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Students Zone - Chapter Introductions

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Chapter 2 - The Balance of Payments

In this chapter we look at one of the most important economic indicators for policymakers in an open economy, namely, the balance of payments. What is happening to a country’s balance of payments often captures the news headlines and can become the focus of attention. A good or bad set of figures can have an influential effect on the exchange rate and can lead policy-makers to change the content of their economic policies. Deficits may lead to the government raising interest rates or reducing public expenditure to reduce expenditure on imports. Alternatively, deficits may lead to calls for protection against foreign imports or capital controls to defend the exchange rate.

Before considering various policy options that may be devised to deal with perceived problems in the balance of payments, we need to consider in some detail exactly what the balance of payments figures are and what is meant by the notion of a balance of payments surplus or deficit. In this chapter, we shall look at what is contained in the balance of payments statistics, how they are compiled and at various possible economic interpretations of the statistics. We also look at how the current account of the balance of payments can be interpreted within the framework of the national income accounts and the effects of changes in governments’ expenditure and exports on the balance of payments.