Page 265 - DECO402_Macro Economics

Macroeconomic Theory

Notes Take point G in Zone I where surplus in balance of payment is added to inflation. In such situation,
for correcting the surplus of balance of payment, exchange rate should be increased and for stopping
inflation expenditure should be reduced. But cut in exchange rate will increase the surplus. It again
expresses the “Dilemma Zone.”
If the country in the situation of full employment and excess in balance of payment at point C of
curve FF then it should increase its rate of exchange. But increase in rate of exchange will create
unemployment. In order to be saved from it, domestic expense must be increased.

At the end, let’s move to point F of Zone II where surplus in balance of payment is added to
unemployment. Here increase in domestic expenditure will be appropriate for both, internal and
external balance. Such policy will increase employment and for reducing the size of surplus, will also
induce increase in import.
Above mentioned analysis presents this that if economy is neither at curve FF (internal balance) nor
at XX curve (external balance), then it is in any one of the four zones.
When for achieving one objective (say, internal balance ), economy follows only one policy or both
expenditure switching and reducing domestic expenditure policies together, then it moves from the
other objective(say, external balance ). This problem arises not only in “Dilemma zones” I and III but
also in “uncomplicated areas” II and IV. For example, if we take point F in Zone II where surplus in
balance of payment is added to unemployment, then expansive policy will reduce unemployment and
will also reduce surplus. But for taking the economy to full equilibrium point E then, price increase
or price decrease exchange rate will have to be accepted which will remove the economy from one
objective or other objective.

Self Assessment

State whether the following statements are True or False:
7. Policies increasing Internal demand by the medium of expansive measures also increase
domestic employment.
8. External balance happens when net exports become zero.
9. Both curves of internal balance and external balance divide the situation in four zones of
economic misfortune.
10. Deficit in balance of payment means deficit of expenditure over income.

29.1 Summary

y Theory of economic (monetary or fiscal) policy has centred around two separate problems.
First, relation between number of policy objectives and number of policy equipments; and
second, allotment of policy equipments for achieving the objectives.

29.2 Keywords

y External balance—Outer balance.
y Internal balance—Balance of inside.

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