balance-of-payments equilibrium

Balance-of-payments equilibriumclick for a larger image
Fig. 14 Balance-of-payments equilibrium. (b) Internal price adjustment.
Balance-of-payments equilibriumclick for a larger image
Fig. 14 Balance-of-payments equilibrium. (a) Exchange rate adjustment.

balance-of-payments equilibrium

a situation where, over a run of years, a country spends and invests abroad no more than other countries spend and invest in it.

Thus, the country neither adds to its stock of INTERNATIONAL RESERVES, nor sees them reduced.

In an unregulated world it is highly unlikely that external balance will always prevail. Balance of payments deficits and surpluses will occur, but provided they are small, balance-of-pay ments disequilibrium can be readily accommodated. The main thing to avoid is a FUNDAMENTAL DISEQUILIBRIUM - a situation of chronic imbalance.

There are three main ways of restoring balance-of-payments equilibrium should an imbalance occur:

  1. external price adjustments. Alterations in the EXCHANGE RATE between currencies involving (depending upon the particular exchange-rate system in operation) the DEVALUATION/DEPRECIATION and REVALUATION/APPRECIATION of the currencies concerned to make exports cheaper/more expensive and imports dearer/less expensive in foreign currency terms. For example, with regard to exports, in Fig. 14 (a), if the pound-dollar exchange rate is devalued from $1.60 to $1.40 then this would allow British exporters to reduce their prices by a similar amount, thus increasing their price competitiveness in the American market.
  2. internal price and income adjustments. The use of deflationary and reflationary (see DEFLATION, REFLATION) monetary and fiscal policies to alter the prices of domestically produced goods and services vis-à-vis products supplied by other countries so as to

make exports relatively cheaper/dearer and imports more expensive/cheaper in foreign currency terms. For example, again with regard to exports, if it ere possible to reduce the domestic price of a British product, as shown in Fig. 14 (b), given an unchanged exchange rate, this would allow the dollar price of the product in the American market to be reduced, thereby improving its price competitiveness vis-à-vis similar American products. The same policies are used to alter the level of domestic income and spending, including expenditure on imports. (c) trade and foreign exchange restrictions. The use of TARIFFS, QUOTAS, FOREIGN-EXCHANGE CONTROLS, etc., to affect the price and availability of goods and services, and of the currencies with which to purchase these products.

Under a FIXED EXCHANGE-RATE SYSTEM, minor payments imbalances are corrected by appropriate domestic adjustments (b), but fundamental disequilibriums require, in addition, a devaluation or revaluation of the currency (a). It must be emphasized, however, that a number of favourable conditions must be present to ensure the success of devaluations and revaluations (see DEPRECIATION 1 for details).

In theory, a FLOATING EXCHANGE-RATE SYSTEM provides an ‘automatic’ mechanism for removing payments imbalances in their incipiency (that is, before they reach ‘fundamental’ proportions): a deficit results in an immediate exchange-rate depreciation, and a surplus results in an immediate appreciation of the exchange rate (see PURCHASING-POWER PARITY THEORY).

Again, however, a number of favourable conditions must be present to ensure the success of depreciations and appreciations. See also ADJUSTMENT MECHANISM, J-CURVE, INTERNAL-EXTERNAL BALANCE MODEL, MARSHAL-LERNER CONDITION, TERMS OF TRADE.