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Posted: August 29th, 2022
Using the Data and Your Economic Knowledge
Using the data and your economic knowledge, evaluate the possible consequences for UK macroeconomic performance if the euro area and the US seek to reduce their balance of payments deficits on current account. The four major objectives are (i) full employment, (ii) price stability, (iii) a high, but sustainable, rate of economic growth, and (iv) keeping the Balance of Payments in equilibrium.
If a country is suffering from inflation and a balance of payments deficit, it is usually because the government is spending too much. In such circumstance, the Fund agrees to lend the country some “transitional funds”, providing the government agrees to reduce its deficit and slow growth in the money supply That should raise the value of sterling, reduce the price of imports, and reduce demand for UK goods and services abroad.
However, the impact of interest rates on the exchange rate is, unfortunately, seldom that predictable. Changes in spending feed through into output and, in turn, into employment. That can affect wage costs by changing the relative balance of demand and supply for workers. But it also influences wage bargainers’ expectations of inflation – an important consideration for the eventual settlement. The impact on output and wages feeds through to producers’ costs and prices, and eventually consumer prices.
Some of these influences can work more quickly than others. And the overall effect of monetary policy will be more rapid if it is credible. But, in general, there are time lags before changes in interest rates affect spending and saving decisions, and longer still before they affect consumer prices. Cutting the interest rate, causing savers to move their money from UK banks to other banks, this will cause a fall in demand for pounds and so a depreciation in the currency.
This will therefore make UK exports seem cheaper abroad, and therefore increase the level of exports as we have greater international competitiveness on price But there are certain draw backs, such as Savers are not garunteed to respond to a cut in the interest rate. and therefore the value of the pound may be unaffected? Lowering the interest rate will increase borrowing and expenditure, including increased expendiiture on imports therefore increasing the Balance of Payments deficit
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