9708 · 6.5
Policies to correct imbalances in the current account of the balance of payments flashcards
Revision flashcards for Cambridge 9708 Policies to correct imbalances in the current account of the balance of payments (syllabus 6.5). Flip, recall, then mark a real past-paper question.
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What is a current account deficit?
When debits on the current account (imports, income outflows, transfers out) exceed credits (exports, income inflows, transfers in).
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Expenditure-reducing policies?
Contractionary fiscal or monetary policy that lowers AD and therefore spending on both domestic goods and imports.
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Expenditure-switching policies?
Policies that redirect spending from imports to domestic goods - e.g. devaluation/depreciation, tariffs, quotas.
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How does devaluation correct a deficit?
Makes exports cheaper abroad and imports dearer at home → net exports rise if Marshall-Lerner condition holds.
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Supply-side policies for competitiveness?
Education, infrastructure, R&D, and labour market reforms that cut costs and improve quality of exports long run.
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Trade-off of expenditure-reducing policy?
May reduce imports but also lowers domestic output and employment - does not address underlying lack of competitiveness.
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What are expenditure-reducing policies?
Policies that aim to correct a current account deficit by reducing aggregate demand (AD), thereby lowering spending on imports. Examples include contractionary fiscal policy (higher taxes, lower government spending) and contractionary monetary policy (higher interest rates).
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What are expenditure-switching policies?
Policies that aim to correct a current account deficit by encouraging consumers to switch from foreign goods to domestic goods. Examples include devaluation/depreciation of the exchange rate and protectionist measures like tariffs and quotas.
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State the Marshall-Lerner Condition.
A condition stating that a currency devaluation/depreciation will only lead to an improvement in the current account balance if the sum of the price elasticities of demand for exports and imports is greater than one (PEDx + PEDm > 1).
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Explain the J-Curve Effect.
The J-Curve effect describes the path of a country's current account balance following a currency devaluation. It initially worsens in the short run (as demand is inelastic) before improving in the long run (as demand becomes more elastic), tracing a 'J' shape on a graph.
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How do supply-side policies help correct a current account deficit?
They improve the long-term international competitiveness of a country's industries by increasing productivity and lowering average costs. This makes exports more attractive (in price and quality) and domestic goods better substitutes for imports, correcting the deficit without causing inflation or unemployment.