Study Notes
A persistent current account deficit can be corrected using various policies, including expenditure switching and reducing policies, trade protection, currency depreciation, and supply-side policies. The Marshall-Lerner condition and J-curve effect explain how currency depreciation can impact trade balance over time.
- Expenditure Switching Policies — policies that shift spending from imports to domestic goods. Example: Trade barriers and currency depreciation.
- Expenditure Reducing Policies — policies that lower aggregate demand to reduce import spending. Example: Contractionary fiscal and monetary policies.
- Trade Protection — measures to restrict imports and protect domestic industries. Example: Tariffs and quotas.
- Depreciation of Currency — a decrease in currency value to make exports cheaper and imports more expensive. Example: Automatic correction of trade deficit.
- Supply Side Policies — policies to enhance domestic market efficiency and competitiveness. Example: Investment in education and infrastructure.
- Marshall-Lerner Condition — states that currency depreciation improves trade balance if the sum of import and export demand elasticities is greater than one. Example: PEDm + PEDx > 1.
- J-Curve Effect — describes the initial worsening of a trade deficit following currency depreciation before improvement. Example: Short-term inelastic demand for imports and exports.
Exam Tips
Key Definitions to Remember
- Expenditure Switching Policies
- Expenditure Reducing Policies
- Trade Protection
- Depreciation of Currency
- Supply Side Policies
- Marshall-Lerner Condition
- J-Curve Effect
Common Confusions
- Confusing expenditure switching with expenditure reducing policies
- Misunderstanding the immediate effects of currency depreciation
Typical Exam Questions
- What are expenditure switching policies? Policies that shift spending from imports to domestic goods.
- How does the Marshall-Lerner condition affect trade balance? It states that if the sum of import and export demand elasticities is greater than one, depreciation improves trade balance.
- What is the J-Curve effect? It describes the initial worsening of a trade deficit following currency depreciation before improvement.
What Examiners Usually Test
- Understanding of different policies to correct a current account deficit
- Application of the Marshall-Lerner condition and J-Curve effect
- Ability to evaluate the effectiveness of various economic policies