Question

1. Discuss the arguments used to justify trade restrictions and critically appraise them.
2. Explain the importance of a country’s balance of payments accounts.
3. Analyze the relationship between a current account deficit/surplus and a capital account deficit/surplus.
4. Discuss the factors that determine exchange rates.
5. Explain why the value of the dollar fluctuates and the importance of understanding this.

Answer 1

Trade increases global production,international efficiency,and consumption across the world. But critics are of the opinion that several arguments justify trade restrictions .One argument is to protect infant industriesor domestic industries. Critics opine that inefficient firms will continue intheir business under this protection for long.Next strategic trade policy ie technological development have led to growth of new industries and changed the old ones.But according to critics firms might use this even if they did not offere any gains to the government.National security and national defence argument is a weak one.Foreign producers should not be relied for defense goods even if the goods are produced at a lower cost.Job protection ie maintaining existing jobs which are threatened by foreign competition .Last is that cheap foreign labor and outsourcing . But critics argue that foreign workers are exploited by offering low wages to them..Free trade may be desired if all the countries abide by same rules.

BOP reflects the country's financial and economic status.It serves as an indicator to state whether the currency of the country is appreciating or depreciating.The government decides on its fiscal and trade policies on the basis of BOP statements.

The current account shows trade in goods and services and capital account shows trade in assets.Thus a current account trade deficit implies a capital account surplus.This is because trade deficit means more goods and services are purchased from abroad than sold to foreigners.Current account surpluses mean the country has more exports than imports.This indicates low domestic demand .Thus current account surplus implies capital account deficit.

Exchange rates are determined by factors like interest rate, confidence ,current account in the balance of payment,economic growth and relative inflation rates.Countries with lower inflation rates will have appreciation in the value of their currency.Again higher interest rtaes cause appreciation and lower interest rates cause depreciation. Confidence /speculation ie if speculators believe that the value of the currency will rise in the future ,demandfor currency will rise which will cause currency to appreciate.The exchange rates will rise if the goods become moreattractive as well as competitive in the market.Strength of other currencies also matter as we see the Japanese and Swiss currency rose because of the US and EU currency.A country which tries to attract capital inflows in order to meet current account deficit , will see depreciation in currency.

There are several reasons for currency fluctuations and inflation in the home country is one factor as countries with low inflation have greater purchasing power and so the value of the currency rises in relation to other currencies.Again high inflation leads to fall in the value of the currency. Change in interest rate is another important factor.Higher interest rates attract  foreign capital to  borrow from that country , thus increasing the exchange rate.Another important factor is the budget of the country.Countries that borrow to finace their infrastructure would like alower value for their currency.

Currency rate indicates the country's economic health.A high valued currency makes imports less expensive and exports more expensive.Currency fluctuations impact consumers .We see that major oil producing countries like Saudi Arabia get their currency pegged to US dollar so that when dollar becomes strong , Saudi Riyal also becomes strong and imports become cheaper .