Essay Plans

What are the possible remedies for a Balance of Payments deficit?

SYNOPSIS:

Define Balance of Payments and discuss devaluation, deflation and import controls bringing in current affairs, diagrams and legislation where necessary.

POINTS:

  1. Define Balance of Payments and its component parts. Explain how the deficit may have arisen (a) over a period of time or as a result of a short-term measure and (b) as a result of a Capital Account deficit. Visible trade deficit, current account deficit or a combination of all three.

  2. Show how the cause of the deficit will of necessity determine the remedy.

  3. Possible causes of the deficit if on current account:-

    • Inflation
    • Industrial action
    • Overvalued exchange rate
    • Poor product design/marketing

  4. Possible reasons for a capital account deficit:-

    • Expectations (derived from 3. above)
    • Low interest rates (how money flows out)
    • Unstable government
    • Speculation elsewhere
    (For further explanation of possible reasons for deficit see essay 20)

  5. Short term remedies:-
    • Borrowing from abroad
    • Draw on foreign currency reserves
    • Propaganda - 'Buy British' Campaign (seen in the 1960's - many of the 'Buy British' T-shirts were made in Portugal - the Union Jack was printed upside down!!)

  6. Long-term : deflation, devaluation, import controls.

  7. Deflation:-
    • Raise taxes
    • Raise interest rates
    • Cut government spending
    • Subsidise home products (more on import control than a deflationary tool). Deflation is primarily an expenditure reducing policy, curing a deficit by dampening demand for everything including imports (UK has a high YED for imports). UK will now - with deflation - have spare capacity that may be used to seek export sales.

  8. Devaluation - this is an expenditure switching policy as important prices will rise and, depending on PED, expenditure will switch to home produced goods (depending on elasticity of supply). In only 45 minutes you haven't time for everything but you should create time for mention of the Marshall Lerner theorem, also a diagram of a J-curve.

  9. Import controls - tariffs, VER's (Voluntary Export Restraint - Japan - 1981 - the car market), quotas, embargoes, subsidies, administrative restrictions etc. Mention of the difficulty of having import controls in the light of 1992.

  10. Policies do not have to be used in isolation : in the 1970s the UK used deflationary policies to support depreciation of the currency (1967 - devalued by 14%).

  11. Note: with deflationary policies eg. high interest rates, this may attract capital therefore leading to a Capital Account surplus. Also, if any of the above are successful - or show signs of being so - the exchange rate may rise, cheapening imports therefore slowing down the recovery.

This essay needs supportive material on current interest rates? Inflation? Deficits etc. (ie Over the last 20 years).

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