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7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 1/19
Balance of Payments Adjustment Policies
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 2/19
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 3/19
Deficits and Surpluses as a share of GDP
Current account deficit as a percentage of GDP
Current Account Balances - Deficits and Surpluses
GermanyIrelandJapan
SpainUnited KingdomUnited States
West Germany
Source: OECD
98 99 00 01 02 03 04 05 06 07 08
-12.5
-10.0
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
P E R C E N T
-12.5
-10.0
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
Why might the deficit
as a share of GDPbe a better guide to
the size of a trade
imbalance?
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 4/19
Are deficits self-correcting?
• Some partial self-correction
• Economic slowdown and recession
– Squeeze on real incomes and output
– Fall in import demand
– Releases capacity for exporting
• Deficit might lead to depreciation in theexchange rate
– Change in relative prices of exports andimports
– Expenditure-switching towards exports andaway from imports
– Depends on price elasticity of demand for Xand M and also elasticity of supply
7/28/2019 BoP Adjustment Policies - AS LEVEL
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The US trade deficit and their recession
$ billion per month
United States Balance of Trade in Goods
Annual growth of real GDP Trade balance in goods and services $bnSource: Reuters EcoWin
01 02 03 04 05 06 07 08
b i l l i o n
s
-70
-65
-60
-55
-50-45
-40
-35
-30
-25
U S D
( b i l l i o n s )
-70
-65
-60
-55
-50-45
-40
-35
-30
-25
-4
-2
0
2
4
6
8
P e r c e n t
-4
-2
0
2
4
6
8
Note the steep fall in
the trade deficit as the
economy hit recession.
Why is income
elasticity of demand
important in this chart?
But what are the wider
economic effects?
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 6/19
Expenditure switching
• Expenditure switching:
– Change in relative prices of X and M
– Changes incentives for consumers
– Changes profitability of exporting
– Can be caused by
• Movement in the exchange rate
• Introduction of import tariffs and other forms
of protectionism
• Period of high or low relative inflation
– Key point is whether trade volumes respond
to changing prices
– I.e. price elasticity of demand for X and M
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 7/19
7/28/2019 BoP Adjustment Policies - AS LEVEL
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Any evidence for the UK?
Quarterly trade balance, £ billion (bottom pane) and exchange rate index
UK Trade & the Sterling Exchange Rate
Effective Exchange Rate Index Balance of Trade in Goods and Services
Source: Reuters EcoWin
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
b i l l i o n s
-15.0
-12.5
-10.0
-7.5
-5.0
-2.5
0.0
Q u a r t e r l y b a l a n c e
£ ( b i l l i o n s )
-15.0
-12.5
-10.0
-7.5
-5.0
-2.5
0.0
70
75
80
85
90
95
100
105
S t e r l i n g i n d e x
70
75
80
85
90
95
100
105
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 9/19
The J Curve
• Effect of a depreciation on the trade deficitdepends on price elasticity of demand.
• In the short term, demand is often inelastic – limits extra revenue from exports
• Demand for M is inelastic – higher prices causea rise in total spending on imports
• The J Curve effect says a trade deficit canworsen after a depreciation, but get better in thelong term provided that the elasticity of demandis high enough
• Marshall-Lerner condition: Trade balance willimprove if Ped X + Ped M . 1
• Elasticity of supply of domestic producers isalso important (often forgotten)
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 10/19
The J Curve effect
Tradesurplus
Trade
deficit
A
Time
B
C
Ped X + Ped M > 1 for
the trade balance to
improve
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 11/19
Expenditure Reduction
• Expenditure reduction
– Cutting aggregate demand
– Direct effect on consumption and thereforedemand for imports:
– Possible routes: • Higher direct taxes – lower disposable
income
• Low taxes on saving
• Increased interest rates – to dampen
consumption • Cut in government spending
– Focus here is on income elasticity of demand for imports
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 12/19
Supply-side policies
• To rebalance trade over the medium term
• Focus on
– Improving competitiveness in global markets:
• Innovation
• Research and development
• Product quality / design
• Infrastructure to support trade sectors
– Attracting inward investment – producing outputdomestically and then exporting
– Raising productivity / lowering unit costs
– Developing areas of new competitive advantage
– Raising foreign income elasticity of demand for exports
– Reducing foreign price elasticity of demand for exports
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 13/19
Weaknesses on supply-side and UK trade
• Persistent productivity gap
• Low business investment as a share of
GDP
•
Low levels of research anddevelopment
• Loss of capacity in manufacturing
industry
• Evidence that UK exports have lower income elasticity of demand than our
income elasticity of demand for imports
7/28/2019 BoP Adjustment Policies - AS LEVEL
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The Productivity Gap
95
100
105
110
115
120
125
130
135
140
1992 1994 1996 1998 2000 2002 2004 2006
Source: ONS
France
Germany
UK
US
GDP per hour workedComparison, 1996-2007
Index, UK = 100
Source: UK competitiveness indicators, Feb 2009
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 15/19
Investment Gap?
Business investmentComparison, 1992-2007Per cent of GDP in current prices
8
10
12
14
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Germany
France
UK
US
Source: OECD
Source: UK competitiveness indicators, Feb 2009
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 16/19
Research Gap?
1.5
2.0
2.5
3.0
1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7
Source: OECD
France
Germany
UK
US
Gross domestic expenditure on R&DComparison, 1992-2006Per cent of GDP
Source: UK competitiveness indicators, Feb 2009
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 17/19
UK Exports and Imports
Annual value of trade - £billion at current prices
UK Exports and Imports of Goods and Services
Source: Reuters EcoWin
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
b i l l i o n s
100
150
200
250
300
350
400
450
G B P
( b i l l i o n s )
100
150
200
250
300
350
400
450
Imports
Exports
Balance of Payments: Exports: Total Trade in Goods & Services 368.337G
Balance of Payments: Imports: Total Trade in Goods & Services 415.817G
7/28/2019 BoP Adjustment Policies - AS LEVEL
http://slidepdf.com/reader/full/bop-adjustment-policies-as-level 18/19
Summary points
• Some trade deficits are partially self correcting
• But recession and a depreciation arenot enough if the root causes lie on thesupply-side of the economy
• Ultimately BoP adjustment requires:
– Period of below trend growth
– Improvement in investment in traded goodsindustries
–Control of price and cost inflation relative tothat of our competitors
– Open trade to drive better exportperformance
– Protectionism is not the answer
7/28/2019 BoP Adjustment Policies - AS LEVEL
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