Discuss whether a country experiencing inflation will always have a balance of payments
problem. (12)
can anyone help me with this question please. its from w06/p2
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time
A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, and financial capital, as well as financial transfers. The BOP summarises international transactions for a specific period, usually a year, and is prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as a negative or deficit item.BOP The types of deficits that typically raise concern are
A visible trade deficit where a nation is importing more physical goods than it exports (even if this is balanced by the other components of the current account.)
An overall current account deficit.
A basic deficit which is the current account plus foreign direct investment (but excluding other elements of the capital account like short terms loans and the reserve account.)
In normal circumstances (if we are not taking elasticities into account).Inflation causes a price rise of exports and causes a decrease in the price of imports.This would naturally reduce the amount of exports the country is selling and increase the amount of imports coming into the country.This would be a cause of severe problems in the future especially if the country begins to rely on imports.
However the affects on Revenue of exports and expenditure on imports depends upon E.D for export and imports.
First assuming the demand for imports and exports is elastic
(Draw two diagrams with only demand curve which should be elastic looking.One diagram should be for exports and one for imports.Inflation would cause a increase in price of export and decrease in price of imports.Draw this price increase and decrease on diagram and you will see revenue of export have decreased drastically whereas for supply it has increased).
From the above diagram it is clear that imports are rising so BOP is falling,however if the demand is inelastic
(do the same but the demand curve should be inelastic looking.)
You will see that Revenue of exports have risen much more then imports so as a result BOP is improving.
(conclusion)The BOP will fall if the demand for export and imports are elastic.If they are not then Inflation may actually improve the BOP.
