The two main approaches to correcting balance of payments imbalances

Governments can address imbalances in the balance of payments through two primary strategies: expenditure-switching policies and expenditure-reducing policies.

Expenditure-switching policies

Expenditure-switching policies encourage purchasers of goods and services, both domestically and internationally, to shift their purchases towards the country's own goods and services, rather than those from abroad. They redirect spending to domestic products rather than reducing total spending in the economy.

Expenditure-reducing policies

Expenditure-reducing policies aim to decrease the total level of spending within the economy.

Expenditure-switching policies and their impacts

Expenditure-switching policies work by altering the relative attractiveness of domestic and foreign goods, steering demand towards home-produced items.

Intended impacts on trade:

• Decrease in import spending - These policies reduce the amount spent on imports.
• Increase in export revenues - They enhance the competitiveness of domestic products on global markets, leading to higher earnings from exports.

Common types of expenditure-switching policies

Governments employ various measures to implement expenditure-switching, often tailoring them to specific industries or economic conditions.

Examples of expenditure-switching policies:

• Supply-side policies - These enhance domestic productivity and efficiency, such as government funding for advanced manufacturing techniques to lower production costs in the electronics sector.
• Protectionist measures - These include barriers that favour local products, like introducing environmental regulations that align with domestic farming practices, making imported agricultural goods less competitive.
• Exchange rate manipulation - This involves adjusting the currency's value, for instance, through deliberate depreciation to make national machinery exports cheaper and more attractive to international buyers.

Expenditure-reducing policies and their effects

Expenditure-reducing policies focus on lowering the total amount of spending in the economy to tackle balance of payments issues.

Key effects on the economy and trade:

• Lower import purchases - Reduced overall spending means fewer purchases of imported goods and services.
• Encouragement of exports - A smaller domestic market pushes local producers to expand sales overseas.
• Net impact on trade - The overall effect may be a fall in imports and a rise in exports.

Common tools for expenditure-reducing policies

To implement expenditure-reducing policies, governments and central banks use tools from fiscal and monetary policy frameworks.

Examples of expenditure-reducing tools:

• Fiscal policy - This includes measures like raising income tax rates on luxury goods while cutting back on government infrastructure projects to limit public expenditure.
• Monetary policy - Central banks might tighten credit by increasing interest rates or setting higher capital reserve ratios for lenders, which restricts borrowing and overall spending.