Economics explained
Category:
Policies to correct balance of payments disequilibrium
Expenditure switching policies
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Direct controls
Direct control is an example of expenditure-switching policies and affects the balance of payments by changing the relative price of home-produced and foreign goods.
Direct controls involve imposing quotas or even outright bans (embargoes) on imports.
These directly cut or prevent expenditure on imports and, as a result, people switch their spending from foreign to home-produced goods.
A government may impose a tariff or increase an existing tariff on imports.
This will encourage domestic consumers and firms to switch to buying domestic products.
Limitation: Imposing tariffs may provoke retaliation and reduce the pressure on domestic firms to become more efficient.
Monetary policy
A government may decide to alter its exchange rate as an expenditure switching measure.
If an economy is experiencing a current account surplus and has a fixed exchange rate, the government may decide to revalue its currency.
Raising the foreign exchange rate will raise export prices and lower import prices.
In the case of a current account deficit, a government may consider devaluing the currency.
In this case, export prices will fall and import prices will rise.
Limitation: Lowering the exchange rate will not work if demand for exports and imports is price inelastic or if the relative quality of the country’s products falls.