Page 264 - DECO402_Macro Economics

Unit-29: Swan Model

That point where curve FF intersects the curve XX, expresses the Bliss point, where economy is in Notes
internal and external balance simultaneously. In figure 29.1 E is such a point, where there exchange
rate and real domestic expenditure are in balanced. If economy is not at point E, then it is in imbalance.
According to Swan, “Both curves of internal balance and external balance divide the situation in four
zones of economic misfortune.” Four zones of imbalance are:-
Zone I: Inflation and payment balance surplus
Zone II: Unemployment and payment balance surplus
Zone III: Unemployment and payment balance deficit
Zone IV: Inflation and payment balance deficit.

Task Express your thoughts about internal and external balance policies.

Policy Measures

For description of types of policy measures, which are important for simultaneously obtaining internal
and external balance, we will take it in eight possible condition of imbalance in figure 29.2. For these
conditions, various combinations of policy measure are important.
Many countries are in equilibrium at point A of
curve XX in payment balance and unemployment
(or recession). For such situation there is need for
extension of domestic economy through increase
in domestic expense. It will reduce net exports. For
making this tendency ineffective devaluation should
be added to increase in domestic expenditure.
If deficit moves along in unemployment and payment
balance, as happens in Zone III at point K, then there
should be an increase in domestic expenditure.
Policies increasing Internd demand by the medium
of expansive measures also increase domestic
employment. But this policy increases the deficit
in balance of payment. It is described in form of Figure 29.2
“dilemma zone” because instead of expansive policy,
devaluation is preferred policy.
In balance of payment, if economy adds full employment with deficit, as happened at point D of curve
FF, the devaluation is its only solution. This huge pre-defined will create surplus and extra foreign
demand will bring inflation in domestic economy. For stopping these tendencies, little devaluation
will have to be added to cut in domestic expenditure.
Take point H in Zone IV where domestic inflation is added to deficit in balance of payment. Inflation
should be stopped by a cut in domestic expenditure which will also reduce deficit in balance of payment
and finally will take the economy towards balanced situation E.
If there is equilibrium of balance of payment and inflation as on point B then it should increase its
rate of exchange and reduce the domestic expenditure.

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