Page 214 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance Pavitar Parkash Singh, Lovely Professional University

Notes Unit 19 : Expenditure Reducing and Expenditure
Switching Policies

CONTENTS
Objectives
Introduction
19.1 The Expenditure Reducing or Changing Policies
19.2 The Expenditure Switching Policy : Devaluation
19.3 Summary
19.4 Key-Words
19.5 Review Questions
19.6 Further Readings

Objectives

After reading this Unit students will be able to:
• Discuss the Expenditure Reducing or Changing Policies.
• Explain the Expenditure Switching Policy.
Introduction

The need for BOP adjustment, particularly of deficit disequilibrium, is clear. A nation’s ability to
absorb deficits is broadly limited by its stock of official international reserves — gold and generally
acceptable foreign currencies — and the willingness of foreign countries to hold its currency as part
of their own international reserves. Accommodating short-term capital borrowings can help in
prolonging BOP deficit adjustments, but they cannot be relied upon indefinitely. Another constraint
to BOP adjustment is the desire on the part of countries to achieve high levels of national income and
employment consistent with price stability. Internal balance cannot be sacrificed for the sake of external
balance.
In the previous unit, we tried to show how BOP adjustment tends to come about more or less
automatically under two different exchange rate systems — one, where the exchange rate is fixed but
prices, interest rates, income levels and capital flows are free to fluctuate; and second, where there is
freely fluctuating exchange rate system. For the effective working of this automatic adjustment
mechanism, there is no need for any policy action by the government; in fact, government non-
intervention is a condition.
It should be stressed, however, that neither of the two self-equilibriating systems conforms to reality.
There is very little ‘automaticity’ in BOP adjustment in the real world. Government intervention,
today, is a fact of life in all countries — developed or underdeveloped. The ‘visible hand’ of government
is seen everywhere — in controlling prices, interest rates, income levels or exchange rates. Indeed,
BOP adjustment has become largely a matter of policy. Government have come to use a wide variety
of policy instruments to achieve BOP equilibrium; and the government policies designed to produce
‘external balance’ cannot afford to ignore questions related to ‘internal balance’. As a matter of fact,
in ordering national priorities, internal balance claims a definite precedence over external balance,
practically, in every country in the world. What we have essentially today, are disequilibrium systems
of national economies.
Let us now proceed to discuss the BOP adjustment methods or policy instruments. They can be
grouped under three broad categories as follows :

208 LOVELY PROFESSIONAL UNIVERSITY