Question

The economy of one of our major trading partners is booming. As a consequence, demand for our exports is at an all-time high. Explain how this development threatens our country’s internal and external balances. Design a policy mix, fiscal and/or monetary, aimed at restoring both internal and external balance.

Answer 1

Demand for exports is at an all-time high, meaning the country is exporting more goods outside the country.

Thus the internal balance will be jeopardized as the domestic economic consumption will not be met by production, because most of the goods are being exported outside the country, this will lead to goods turning expensive because of less number of goods available locally.

External balance will be in surplus as the country is exporting more than importing. If it has a large external surplus, it might mean that the domestic demand is weak and thus lower spending on imports, which might impact domestic employment in the economy.

Through fiscal measures by incurring government expenditure, the domestic government can improve consumption of its goods by increasing employment in the economy, this could increase domestic consumption thereby balancing the external account as imports could increase, whereas the internal balance could be steady by increasing the excise duty on exports, which is imposing tax on the goods exported so that number of goods available in the domestic economy increases and local prices don't inch up.