Balance of Payments Adjustment Policies
Policies to correct a BoP imbalance
• Most discussions focus on countries
running a current account deficit
• But persistent surpluses can also be a
problem!
• Both deficit and surplus can be
described as a disequilibrium
• Evaluation might consider:
–
–
–
–
Automatic partial correction of a deficit
Demand-side policies
Supply-side policies
The consequences of policies for other
macroeconomic objectives such as growth,
inflation and jobs
Deficits and Surpluses as a share of GDP
Current Account Balances - Deficits and Surpluses
PERCENT
Current account deficit as a percentage of GDP
10.0
10.0
7.5
7.5
5.0
5.0
2.5
2.5
0.0
0.0
-2.5
-2.5
-5.0
-5.0
-7.5
-7.5
-10.0
-10.0
-12.5
-12.5
98
99
Germany
Ireland
Japan
00
01
02
03
Spain
United Kingdom
United States
04
05
06
07
08
West Germany
Source: OECD
Why might the deficit
as a share of GDP
be a better guide to
the size of a trade
imbalance?
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 the
exchange rate
– Change in relative prices of exports and
imports
– Expenditure-switching towards exports and
away from imports
– Depends on price elasticity of demand for X
and M and also elasticity of supply
The US trade deficit and their recession
United States Balance of Trade in Goods
$ billion per month
6
6
4
4
2
2
0
0
-2
-2
-4
-4
-25
-25
-30
-30
-35
-35
-40
-40
-45
-45
-50
-50
-55
-55
-60
-60
-65
-65
-70
-70
01
02
03
Annual growth of real GDP
04
05
06
07
USD (billions)
Note the steep fall in
the trade deficit as the
economy hit recession.
Why is income
elasticity of demand
important in this chart?
billions
8
Percent
8
08
Trade balance in goods and services $bn
Source: Reuters EcoWin
But what are the wider
economic effects?
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
Does a depreciation cut the trade deficit?
US Trade Deficit and the US Dollar
130
130
125
125
120
120
115
Dollar depreciating
115
110
110
105
105
100
100
95
95
-25
-30
-35
-40
-45
-50
-55
-60
-65
-70
-25
-30
-35
-40
-45
-50
-55
-60
-65
-70
00
01
02
03
04
05
06
07
08
billions
USD (billions)
Index
trade balance $ billion per month, dollar exchange rate index
09
Federal Reserve, Nominal Trade Weighted Exchange Index Broad
Trade Balance, Total, Goods and services, SA
Source: Reuters EcoWin
Any evidence for the UK?
UK Trade & the Sterling Exchange Rate
105
105
100
100
95
95
90
90
85
85
80
80
75
75
70
70
0.0
0.0
-2.5
-2.5
-5.0
-5.0
-7.5
-7.5
-10.0
-10.0
-12.5
-12.5
-15.0
-15.0
billions
Quarterly balance £ (billions)
Sterling index
Quarterly trade balance, £ billion (bottom pane) and exchange rate index
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Effective Exchange Rate Index
Balance of Trade in Goods and Services
Source: Reuters EcoWin
The J Curve
• Effect of a depreciation on the trade deficit
depends 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 cause
a rise in total spending on imports
• The J Curve effect says a trade deficit can
worsen after a depreciation, but get better in the
long term provided that the elasticity of demand
is high enough
• Marshall-Lerner condition: Trade balance will
improve if Ped X + Ped M . 1
• Elasticity of supply of domestic producers is
also important (often forgotten)
The J Curve effect
Trade
surplus
Ped X + Ped M > 1 for
the trade balance to
improve
Time
C
A
Trade
deficit
B
Expenditure Reduction
• Expenditure reduction
– Cutting aggregate demand
– Direct effect on consumption and therefore
demand 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
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 output
domestically 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
Weaknesses on supply-side and UK trade
• Persistent productivity gap
• Low business investment as a share of
GDP
• Low levels of research and
development
• Loss of capacity in manufacturing
industry
• Evidence that UK exports have lower
income elasticity of demand than our
income elasticity of demand for imports
The Productivity Gap
GDP per hour worked
Comparison, 1996-2007
Index, UK = 100
140
135
130
France
125
Germany
120
UK
115
US
110
105
100
95
1992
1994
1996
1998
2000
2002
2004
2006
Source: ONS
Source: UK competitiveness indicators, Feb 2009
Investment Gap?
Business investment
Comparison, 1992-2007
Per cent of GDP in current prices
14
12
Germany
France
10
UK
US
8
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: OECD
Source: UK competitiveness indicators, Feb 2009
Research Gap?
Gross domestic expenditure on R&D
Comparison, 1992-2006
Per cent of GDP
3.0
France
2.5
Germany
UK
US
2.0
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
1.5
Source: OECD
Source: UK competitiveness indicators, Feb 2009
UK Exports and Imports
UK Exports and Imports of Goods and Services
Annual value of trade - £billion at current prices
450 Balance of Payments: Exports: Total Trade in Goods & Services 368.337G
Balance of Payments: Imports: Total Trade in Goods & Services
450
415.817G
400
400
350
350
300
300
billions
GBP (billions)
Imports
250
250
Exports
200
200
150
150
100
100
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
Source: Reuters EcoWin
Summary points
• Some trade deficits are partially self
correcting
• But recession and a depreciation are
not enough if the root causes lie on the
supply-side of the economy
• Ultimately BoP adjustment requires:
– Period of below trend growth
– Improvement in investment in traded goods
industries
– Control of price and cost inflation relative to
that of our competitors
– Open trade to drive better export
performance
– Protectionism is not the answer