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Macroeconomic Objectives (A2)

The balance of payments: Solutions to current account deficits

  • 3 things to know
  • A2 Units 3 and 4

Overview

Recall questions on Solutions to current account deficits.

What you need to know

Answer each one before you reveal it.

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Key term

What is the difference between a structural and a cyclical balance of payments deficit?

Key term

How can deflationary policies improve the balance of payments?

Key term

How can supply side reforms improve the balance of payments?

Questions from this subtopic

Each one with the model answer underneath.

  1. 1

    What is the difference between a structural and a cyclical balance of payments deficit?

    Model answer

    A structural deficit is caused by long-term fundamental weaknesses in the economy's competitiveness, while a cyclical deficit is caused by temporary fluctuations in economic activity related to the business cycle.

  2. 2

    Why is it important to distinguish between structural and cyclical imbalances when analysing the balance of payments?

    Model answer

    Because the appropriate policy response differs; cyclical imbalances may self-correct as the economy moves through the business cycle, while structural imbalances require longer-term supply-side reforms.

  3. 3

    Explain how exchange rate policies can be used to address balance of payments imbalances.

    Model answer

    Governments can depreciate or devalue the currency to make exports cheaper and imports more expensive, improving price competitiveness and the current account balance.

  4. 4

    What is a potential limitation of using exchange rate depreciation to correct a current account deficit?

    Model answer

    It may cause imported inflation, and the improvement depends on the price elasticity of demand for exports and imports (Marshall-Lerner condition).

  5. 5

    How can deflationary policies improve the balance of payments?

    Model answer

    Deflationary policies reduce domestic demand, which decreases spending on imports and may free up capacity for exports, improving the current account.

  6. 6

    What is a potential cost of using deflationary policies to correct a balance of payments deficit?

    Model answer

    They may cause higher unemployment and lower economic growth as aggregate demand falls.

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