Question

Question one

1- What is meant by an external balance and what are the expenditure switching policies that might be use to improve the external balance. Explain.

2- A balance of payment surplus may lead to inflation, while a balance of payment deficit may lead to unemployment. Explain this statement.

3- Implementation of the Fiscal Policy will lead to an increase in interest rates thus affecting internal and external balances. What is the sterilization policies that can be taken by the government to offset this internal and external imbalances.

4- Assume interest rates in Malaysia are currently 5%, and you expect the Japanese Yen to appreciate by 2%. How much interest would Japanese government have to pay on its government bonds for Malaysia to buy them.

Answer 1

1.No country is self-sufficient in itself. So it export some goods and services and import others. External balance is a situation in which the money which a country receives by exports is equal to money it spends on imports. In this situation, current account is neither positive nor negative. It simply states that a country should export something and import others. In this way, external balance is achieved. Maintaining external balance is one of the objective of any country.

Expenditure switching policies is mainly a macroeconomic policy that is meant to affect the composition of country's expenses on foreign and domestic goods. Expenditure switching policies mainly include devaluation or Revaluation meant to bring equilibrium level of output.Devaluation increases the domestic price of imported goods and decreases foreign price of exports. Thus, it reduces imports and increases exports. It is meant to improve current account balance but that too depends on elasticity of demand of export and import. When the sum of elasticity of demand of export and import is more than one then devalution results in improvement in current account balance.

2.Balance of payments is the record of all economic transactions between the residents of the country with the rest of the world. Balance of payments surplus is a condition in which a country export more than what it imports. The country will have more savings to spend and it can also boost production. As a result, money supply increases in the market and people have more money due to more exports than imports. Because of increased production, unemployment is reduced and money with Bank and general public is more leading to inflationary situation.

Balance of deficit is a situation when a country imports more than exports. It has to borrow from other countries to pay fir the imported goods and services Because of low production due to scarcity of money supply there is unemployment situation. Moreover, many labourers are removed from the job due to low demand of the produced goods and slow production also.

3.Fiscal policy applies government spending and taxing power to produce a effect on economy. Fiscal policy along with monetary policy can effect interest rate,personal spending, capital expenditure. By strict policy it can reduce money supply and increase interest rates

Two types of policies are used to bring equibrium in internal and external balance. It includes combination of expenditure - reducing and expenditure - switching policies. Expenditure - reducing policies reduce aggregate demand through ugh higher taxes and interest rate. Ultimately, expenditure and output is reduced and lower the price. So there is switching of expenses from foreign to domestic goods. It results in reduction of imports. Expenditure switching policies increases demand for domestic goods. Expenses are used for domestic goods than foreign goods. It this increases home production of goods. Thus expenditure switching policy of devaluation must be used with expenditure reducing policy of tight monetary and fiscal policy to maintain full employment.