9708 · 11.1
Policies to correct disequilibrium in the balance of payments flashcards
Revision flashcards for Cambridge 9708 Policies to correct disequilibrium in the balance of payments (syllabus 11.1). Flip, recall, then mark a real past-paper question.
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Expenditure-switching policies?
Policies that redirect spending from imports to domestic goods — e.g. devaluation/depreciation, tariffs, import quotas.
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Expenditure-reducing policies?
Contractionary fiscal/monetary policy — lower AD → lower income → lower import spending.
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Marshall–Lerner condition?
Devaluation improves trade balance if PEDx + PEDm > 1 — export and import volume responses outweigh price effects.
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What is the J-curve?
Trade balance may worsen initially after devaluation (contracts priced in old rates) before improving as volumes adjust.
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Supply-side BOP policy?
Raise productivity and quality — improves export competitiveness without reducing domestic demand.
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Deflationary policy cost?
Reduces imports (helps BOP) but also lowers output, employment, and growth — internal objective conflict.
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What are expenditure-switching policies?
Policies designed to correct a current account deficit by making domestic goods relatively cheaper than foreign goods, encouraging a switch in spending. Examples include currency devaluation and tariffs.
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What are expenditure-reducing policies?
Policies designed to correct a current account deficit by reducing aggregate demand in the economy, which in turn reduces demand for imports. Examples include contractionary fiscal (higher taxes) and monetary (higher interest rates) policy.
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State the Marshall-Lerner condition.
For a currency devaluation to improve the current account balance, the sum of the price elasticity of demand for exports (PEDx) and the price elasticity of demand for imports (PEDm) must be greater than one. Formula: PEDx + PEDm > 1.
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Briefly describe the J-Curve effect.
The J-Curve shows that following a currency devaluation, the current account deficit may initially worsen due to low short-term price elasticities of demand before improving as demand for exports and imports becomes more price elastic over time.
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What is a major policy conflict associated with using expenditure-reducing policies?
These policies, such as raising interest rates or cutting government spending, reduce aggregate demand to cut import spending. However, this can lead to a recession, higher unemployment, and slower economic growth, creating a conflict with other key macroeconomic objectives.