Balance of Payments Problem

• Consequences of a current account deficit or surplus

• Methods of correction
  • Devaluation of currency

• managed changes in exchange rates

• reduction in aggregate demand/expenditure-reducing policies
  • Increases in taxes/interest rates to shore up spending within a country.
  • Protectionism: reduces imports
  • Currency controls: restricts the amount of foreign currency bought by domestic citizens
  • Supply-side policies: aimed at reducing labor costs, increasing firms' competitiveness

• change in supply-side policies to increase competitiveness

• protectionism/expenditure-switching policies

• Consequences of a capital account deficit or surplus

• Marshall-Lerner condition

  States that a devaluation of a country's currency will benefit the country's balance of payments only if the combined elasticity values of exports and imports (in absolute value) are greater than 1.

• J-curve

  A theory which indicates that running a current account deficit may prove to worsen the country's balance of payments situation before improvement is observed, possibly due to the time lag.