Online Currency Trade

Financing and Expenditure-changing Policies

Governments basically have two policy options--- when confronted by balance of payments disequilibrium.

It could go one way or the other--- the disequilibrium may be financed, or the government adjusts to it.

Instead, in the case of deficit (surplus), they seek to sell (buy) foreign exchange or to intervene in the financial and exchange markets to induce inward (outward) movements of private short-term capital.

Financing implies that the authorities are prepared to counteract (sterilize) any impact of the consequent change of the country's net foreign liquidity on internal purchasing power by conducting domestic open-market operations in government securities, or by adjusting private bank reserve requirements or liquidity ratios.

Incomes and prices, the existing demand and supply schedules of foreign exchange, and the prevailing exchange rate are all meant to remain as before.

The payments gap is to be closed simply by accommodating flows of public and/or private funds.

Financing requires that governments have access to some kind of stockpile of internationally acceptable liquid assets.

That is the reason why every national government traditionally holds a certain quantity of official monetary reserves.

Finally, financing requires an adequately large pool of government securities for domestic open-market operations or sufficient latitude for adjusting private bank reserve requirements or liquidity ratios for the complementary policy of sterilization to be practicable.

Adjustment, by contrast, implies that the authorities are prepared to accept a marginal reallocation of resources and exchanges, either by actively reinforcing the automatic market response to a payments disequilibrium (or at least allowing that response to operate by reacting passively)

Or it could go the opposite: by promoting an alternative market response. Governments have a wide range of balance of payments adjustment policies at their disposal.

In fact, their range of choice is virtually as wide as that for national economic policy in general, since nearly all instruments of national economic policy are capable of influencing the balance of payments in some degree, great or small.

Payments adjustment policies may be classified under two headings, expenditure-changing policies and expenditure-switching policies, depending on whether they rely primarily on income changes or on price changes.

Expenditure-changing policies rely primarily on income changes, and aim to adjust to a deficit (surplus) by means of deflationary (expansionary) monetary and fiscal policies.

Monetary policy involves the use of variations in the quantity of money to decrease or increase aggregate demand.

Fiscal policy involves the use of taxation and expenditure policies by the government sector to decrease aggregate demand (monetary and fiscal policy together often are designated as financial policy).