International Economics

INTERNATIONAL ECONOMICS
Unit 4
Prepared By
Ms. Jissy.C
Assistant Professor
Ms.Jissy.C,Assisatant Professor
1

FOREIGN ECONOMIC POLICIES
 Economic policy refers to the actions that governments take in
the economic field. It covers the systems for setting levels
of taxation, government budgets, the money supply and interest rates as
well as the labor market, national ownership, and many other areas of
government interventions into the economy.
 Most factors of economic policy can be divided into either fiscal policy,
which deals with government actions regarding taxation and spending,
or monetary policy, which deals with central banking actions regarding the
money supply and interest rates.
 Such policies are often influenced by international institutions like
the International Monetary Fund or World Bank as well as political beliefs
and the consequent policies of parties.
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 Three main types of government macroeconomic policies are as follows: 1. Fiscal Policy 2.
Monetary Policy 3. Supply-side Policies
 Fiscal Policy:
 Fiscal policy refers to changes in government expenditure and taxation. Government expenditure, also called
public expenditure, and taxation occur at two main levels – national and local. Governments spend money on
a variety of items including benefits (for the retired, unemployed and disabled), education, health care,
transport, defense and interest on national debt.
 A government sets out the amount it plans to spend and raise in tax revenue in a budget statement. A budget
deficit is when the government’s expenditure is higher than its revenue. In this case, the government will have
to borrow to finance some of its expenditure.
 In contrast, a budget surplus occurs when government revenue is greater than government expenditure. A
balanced budget, which occurs less frequently, is when government expenditure and revenue are equal. A
government may deliberately alter its expenditure or tax revenue to influence economic activity.
 If a government wants to raise aggregate demand in order to increase economic growth and employment, it
will increase its expenditure and/or cut taxation by lowering tax rates, reducing the items taxed or raising tax
thresholds. For example, a government may cut income tax rates.
 This will raise people’s disposable income, which will enable them to spend more. Higher consumption is also
likely to raise investment. A government may implement a deflationary fiscal policy (also called a
contractionary fiscal policy) to reduce inflationary pressure. A cut in government expenditure on, for instance,
education would reduce aggregate demand. Such a reduction may lower the rise in the general price level.
3

 Monetary Policy:
 Monetary policy includes changes in the money supply, the rate of interest and the exchange rate,
although some economists treat changes in the exchange rate as a separate policy. The main monetary
policy measure, currently used in most countries, is changes in the rate of interest.
 A rise in the rate of interest helps implement a deflationary monetary policy. It will be likely to reduce
aggregate demand by lowering consumption and investment. Households will spend less due to availability
of less discretionary income, expensive borrowing and greater incentive to save.
 Firms will invest less as they will expect consumption to be lower. Also the opportunity cost of
investment will have risen and borrowing will have become expensive. A higher interest rate may also
reduce aggregate demand by lowering net exports.
 Changes in the money supply, as with changes in interest rates, are implemented by Central Banks on
behalf of governments. If the money supply is increased by the Bank printing more money, buying back
government bonds or encouraging commercial banks to lend more, the aggregate demand increases. On the
other hand, a decrease in the money supply reduces aggregate demand.
4

 Supply-side Policies:
 Supply-side policies are policies designed to increase aggregate supply and hence increase productive
potential. Such policies seek to increase the quantity and quality of resources and raise the efficiency of
markets. These include improving education and training, cutting direct taxes and benefits, reforming
trade unions and privatization. Improving education and training is designed to raise labour productivity.
 The intention behind cutting direct taxes and benefits is to make work more attractive, relative to living
on benefits. If successful, this will make the unemployed search for work more actively and will raise the
labour force by encouraging more people (including for instance married women and the disabled) to
seek employment. Reforming trade unions may make labour more productive and privatization may
increase productive capacity, if private sector firms invest more and work more efficiently than state
owned enterprises.
5

 INTERNATIONAL LIQUIDITY
 Meaning of International Liquidity:
 International liquidity is defined as the aggregate stock of internally acceptable assets held by the central
bank to settle a deficit in a country’s balance of payments. In other words, international liquidity provides a
measure of a country’s ability to finance its deficit in balance of payments without resorting to adjustment
measures. Shortage of liquidity hampers the expansion of global trade and its surplus leads to global
inflationary pressures.
 International liquidity is generally used as a synonym for international reserves. Such reserves include a
country’s official gold stock holdings, its convertible foreign currencies, SDRs, and its net reserve position in
the IMF. Economists like Heller and McKinnon use a broader definition of international liquidity to include
international borrowings, commercial credit operations, and the international financial structure in a country’s
reserves.
 Unconditional international liquidity consists of a country’s official gold stock, holdings of its foreign
currencies and SDRs, its net position in the IMF, and private holding of international assets. In all such cases,
liquidity assets are available to the country without any conditions or restrictions on their use. But in the case
of borrowed reserves, the lender country may impose conditions or restrictions on the use of liquid assets by
the borrowing country.
6

Problem of International Liquidity:
The principal causes for the shortage of international liquidity are the following:
1. BOP Deficits:
 There have been increasing BOP deficits of the majority of countries in the world. In particular, after the
opening of LDCs to world markets, these countries have been facing persistent BOP deficits. Too much
dependence on exports has exposed these economies to international fluctuations in the demand for and prices
of their products.
 They have become unstable due to international cyclical instability. On the other hand, their import
requirements have been on the increase in order to develop. As a result, they are faced with foreign exchange
constraints. This has necessitated larger inflow of aid and foreign investment.
 Consequently, debt serving and interest on debt have risen and payments of dividends, profits and royalties on
private direct foreign investment have grown, thereby leading to decline in the net inflow of foreign capital. All
these have led to further shortage of foreign exchange reserves.
2. High Tariff Barriers:
 The exports of LDCs to developed countries have not been increasing, thereby adversely affecting their export
earnings. One of the reasons for the non-expansion of their exports has been high tariff barriers imposed by the
developed countries on their exports, especially by their regional groups like the EEC.
 At the same time, the LDCs are trying to cut down their essential imports from the developed countries by
means of exchange controls, high tariffs, import quotas and similar protectionist devices in order to conserve
foreign exchange. This has adversely affected their development process.
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3. Attitude of Developed Countries:
The majority of developed countries have surplus in their balance
of payments. They are creditors of LDCs and do not take any
interest in getting rid of their surplus so as to increase international
liquidity.
4. Unequal Distribution of International Reserves:
The distribution of international reserves is biased and favours the
developed countries. It is primarily based on their quotas in the
IMF. Whenever the IMF quotas are revised, the larger share goes to
the developed countries. It is the developing countries whose need
for international liquidity is far greater which suffer from its
shortage.
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 Measures to Solve the Problem of International Liquidity:
The following measures have been suggested to solve the problem of international liquidity:
 1. Promoting Export Expansion:
Developing countries should reduce BOP deficit by promoting export expansion. The choice lies
in concentrating the expansion of primary or secondary products or both. The expansion of
secondary products requires import substitution for export expansion. These policies will earn
them foreign exchange.
 2. Limiting Exports:
They should ban non-essential consumer goods, and limit imports of specific goods by selective
tariffs, physical quotas, etc. This policy will enable them to conserve foreign exchange.
 3. Changing Official Exchange Rate:
A developing country can change its official exchange rate by devaluing its currency so that its
export prices are lowered and import prices are increased. This will help in earning foreign
exchange.
9

 4. Restrictive Monetary-Fiscal Policies:
By following restrictive monetary and fiscal policies, a developing country can reduce
domestic demand for products which will lower import prices, reduce inflationary
pressures and BOP deficit.
 5. Reduction in BOP Surplus:
The majority of developed countries have BOP surplus which they should reduce
by:
(a) Accepting the national currencies of developing countries for payments;
(b) Removal of trade barriers to the products of developing countries; and
(c) Accepting products of developing countries in exchange for their products, as was
done by the erstwhile USSR.
 6. Expanding International Reserves:
The IMF should expand international reserves by fresh allocation of larger quotas to
member countries. In particular, all new issues of SDRs should be distributed to
developing countries so that they may pay then to developed countries to solve their
foreign exchange problem.
10

 Euro-Dollar Market:
 Euro-dollar market is the creation of the international bankers. It is simply a short-term money
market facilitating banks’ borrowings and lendings of U.S. dollars. The Euro-dollar market is
principally located in Europe and basically deals in U.S. dollars.
 But, in a wider sense, Euro-dollar market is confined to the external lending and borrowing of the
world’s most important convertible currencies like dollar, pound, sterling, Swiss franc, French franc,
Deutsche mark and the Netherlands guilder.
 In short, the term Euro-dollar is used as a common term to include the external markets in all the
major convertible currencies.
 Euro-dollar operations are unique in character, since the transactions in each currency are made
outside the country where that currency originates.
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 characteristics:
 1. It has emerged as a truly international short-term money market.
 2. It is unofficial but profound.
 3. It is free.
 4. It is competitive.
 5. It is a more flexible capital market.
 Euro-dollar market has two facts:
 (i) It is a market which accepts dollar deposits from the non-banking public and gives credit in
dollars to the needy non-banking public.
 (ii) It is an inter-bank market in which the commercial banks can adjust their foreign currency
position through inter-bank lending and borrowing.
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 Benefits of the Euro-Dollar Market:
 Following benefits seem to have accrued to the countries involved in the Euro-dollar
market:
 1. It has provided a truly international short-term capital market, owing to a high degree of mobility
of the Euro-dollars.
 2. Euro-dollars are useful for the financing of foreign trade.
 3. It has enabled the financial institutions to have greater flexibility in adjusting their cash and
liquidity positions.
 4. It has enabled importers and exporters to borrow dollars for financing trade, at cheaper rates
than otherwise obtainable.
 5. It has helped in reducing the profit margins between deposit rates and lending rates.
 6. It has enhanced the quantum of funds available for arbitrage.
 7. It has enabled monetary authorities with inadequate reserves to increase their reserves by
borrowing Euro-dollar deposits.
 8. It has enlarged the facilities available for short-term investment.
 9. It has caused the levels of national interest rates more akin to international influences
13

 Effects of Euro Dollar Market on International Financial System:
 1. The position of dollar has been strengthened temporarily, since its operations of borrowing of
dollars have become more profitable rather than its holdings.
 2. It facilitates the financing of balance of payments surpluses and deficits. Especially, countries
having deficit balance of payments tend to borrow funds from the Euro-dollar market, thereby
lightening the pressure on their foreign exchange reserves.
 3. It has promoted international monetary cooperation.
 4. Over the last decade, the growth of Euro-dollar has helped in easing of the world liquidity
problem.
 Shortcomings of the Euro-Dollar Market:
 The major drawbacks of the Euro-dollar market may be mentioned as under:
 1. It may lead banks and business firms to overtrade.
 2. It may weaken discipline within the banking communities.
 3. It involves a grave danger of sudden large- scale withdrawal of credits to a country.
 4. It has rendered official monetary policies less effective for the countries involved.
14

Devaluation
 Devaluation means decreasing the value of nation's currency relative to gold or the
currencies of other nations. Under it , there is no change in the internal purchasing power
of the currency.
 • For example, Rs 25=1$ (before devaluation) Rs 30=1$ (after devaluation) • In modern
monetary policy, it is a reduction in the value of currency with respect to those goods,
services or other monetary units with which that currency can be exchanged
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EFFECTS OF A DEVALUATION
 1. Exports cheaper. A devaluation of the exchange rate will make exports more
competitive and appear cheaper to foreigners. This will increase demand for exports.
Also, after a devaluation, UK assets become more attractive; for example a devaluation
in the Pound can make UK property appear cheaper to foreigners.
 2. Imports more expensive. A devaluation means imports, such as petrol, food and raw
materials will become more expensive. This will reduce demand for imports. It may also
encourage British tourists to take a holiday in UK, rather than US – which now appears
more expensive.
 3. Increased aggregate demand (AD). A devaluation could cause higher economic
growth. Part of AD is (X-M) therefore higher exports and lower imports should increase
AD (assuming demand is relatively elastic). In normal circumstances, higher AD is
likely to cause higher real GDP and inflation.
16

 4.Inflation is likely to occur following a devaluation because:
Imports are more expensive – causing cost push inflation.
AD is increasing causing demand pull inflation
With exports becoming cheaper manufacturers may have less incentive to cut costs
and become more efficient. Therefore over time, costs may increase.
 5. Improvement in the current account. With exports more competitive and
imports more expensive, we should see higher exports and lower imports, which
will reduce the current account deficit. In 2016, the UK had a near record current
account deficit, so a devaluation is necessary to reduce the size of the deficit.
 6. Wages. A devaluation in the Pound makes the UK less attractive for foreign
workers. For example, with fall in the value of the Pound, migrant workers from
Eastern Europe may prefer to work in Germany than the UK. In the UK food
manufacturing industry, more than 30% of workers are from the EU. UK firms may
have to push up wages to keep foreign labour. Similarly, it becomes more attractive
for British workers to get a job in the US, because a dollar wage will go further.
(FT – migrants become more picky about UK jobs)
17

 EVALUATION OF A DEVALUATION
 1. Elasticity of demand for exports and imports.
If demand is price inelastic, the a fall in the price of exports will lead to only a small rise in quantity. Therefore, the value of
exports may actually fall. An improvement in the current account on the balance of payments depends upon the Marshall
Lerner condition and the elasticity of demand for exports and imports
If PEDx + PEDm > 1 then a devaluation will improve the current account
The impact of a devaluation may take time to have effect. In the short term, demand may be inelastic, but over time demand
may become more price elastic and have a bigger effect.
 2. State of the global economy.
If the global economy is in recession, then a devaluation may be insufficient to boost export demand. If growth is strong, then
there will be a greater increase in demand. However, in a boom, a devaluation is likely to exacerbate inflation.
 3. Inflation.
The effect on inflation will depend on other factors such as:
Spare capacity in the economy. E.g. in a recession, a devaluation is unlikely to cause inflation.
Do firms pass increased import costs onto consumers? Firms may reduce their profit margins, at least in the short run.
Import prices are not the only determinant of inflation. Other factors affecting inflation such as wage increases may be
important.
 4. It depends why the currency is being devalued.
 If it is due to a loss of competitiveness, then a devaluation can help to restore competitiveness and economic growth. If the
devaluation is aiming to meet a certain exchange rate target, it may be inappropriate for the economy.
18

 EVALUATION OF A DEVALUATION
 1. Elasticity of demand for exports and imports. If demand is price inelastic, the a fall in the price
of exports will lead to only a small rise in quantity. Therefore, the value of exports may actually fall. An
improvement in the current account on the balance of payments depends upon the Marshall Lerner
condition and the elasticity of demand for exports and imports
 State of the global economy. If the global economy is in recession, then a devaluation may be
insufficient to boost export demand. If growth is strong, then there will be a greater increase in
demand. However, in a boom, a devaluation is likely to exacerbate inflation.
 3. Inflation. The effect on inflation will depend on other factors such as:
 Spare capacity in the economy. E.g. in a recession, a devaluation is unlikely to cause inflation.
 Do firms pass increased import costs onto consumers? Firms may reduce their profit margins, at least
in the short run.
 Import prices are not the only determinant of inflation. Other factors affecting inflation such as wage
increases may be important.
 4. It depends why the currency is being devalued. If it is due to a loss of competitiveness, then a
devaluation can help to restore competitiveness and economic growth. If the devaluation is aiming to
meet a certain exchange rate target, it may be inappropriate for the economy.
19

 DEVELOPMENT OF UNDER DEVELOPED COUNTRIES
 Need for Planning in Underdeveloped Countries
 1. Rapid Economic Development
 2. Balanced Growth
 3 Development of Socio-economic Overheads
 4. Mobilization of Resources
 5. Reduction of Economic Inequalities
20

 UNITED NATIONS FINANCIAL PROGRAMS
 • United Nations Development Program (UNDP)
 • Office of the United Nations High Commissioner for Refugees (UNHCR)
 • United Nations Children's Fund (UNICEF)
 • World Food Program (WFP)
 • United Nations Drug Control Program (UNDCP)
 • United Nations Population Fund (UNFPA
 • United Nations Environment Program (UNEP)
 • UN Women
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 Un Specialized Agencies
 • World Bank
 • International Monetary Fund (IMF)
 • World Health Organization (WHO)
 • United Nations Educational, Scientific and Cultural Organization (UNESCO)
 International Labor Organization (ILO)
 • Food and Agriculture Organization (FAO)
 • International Maritime Organization (IMO)
 • World Meteorological Organization (WMO
 World Intellectual Property Organization (WIPO)
 • International Civilian Aviation Organization (ICAO
 United Nations specialized agency for information and communication technologies
(ICT)
22

 Debt crisis
 Debt crisis is a situation in which a government (nation,
state/province, county, or city etc.) loses the ability of paying back its
governmental debt. When the expenditures of a government are
more than its tax revenues for a prolonged period, the government
may enter into a debt crisis. Various forms of governments finance
their expenditures primarily by raising money through taxation.
When tax revenues are insufficient, the government can make up
the difference by issuing debt.
23

 World Debt Crisis
 Governments, companies and households raised $24 trillion last year to offset the
pandemic’s economic toll, bringing the global debt total to an all-time high of $281 trillion by
the end of 2020, or more than 355% of global GDP, according to the Institute of
International Finance.
 They may have little choice but to keep borrowing in 2021, said Washington-based director
of sustainability research Emre Tiftik and economist Khadija Mahmood.
 Even as vaccines are rolled out, low central bank policy rates are keeping issuance above
pre-pandemic levels. Governments with big budget deficits are set to increase debt by
another $10 trillion this year as political and social pressures make it hard to curb
spending, pushing this group’s debt load past $92 trillion by end-2021, the IIF estimates.
24

 “The most important challenge is to find a well-designed exit strategy from these
extraordinary fiscal measures,” Tiftik said during a Wednesday webinar.
 Both mature and emerging markets will be searching for a perfect balance. While an
economic recovery may lead some governments to start developing strategies to roll back
stimulus, doing so too soon could magnify default and bankruptcy risk. But waiting too long
could lead to unwieldy debt loads.
 Even amid historically muted credit spreads, global debt markets have started selling off,
pushing up sovereign yields. Long-term U.S. Treasury yields reached the highest in about
a year this week.
 Heavy Load
 Global debt climbed to all-time high of $281 trillion last year
25

 Increases in non-financial industry debt-to-GDP ratios in France, Spain and Greece were
among the sharpest in mature economies, as governments rapidly ramped up borrowing.
In emerging markets, China saw the biggest jump in debt ratios last year, followed by
Turkey, Korea and the United Arab Emirates, IIF data show.
 Here’s what else to know:
 Non-financial corporates are becoming more reliant on government support, which may
exacerbate pre-existing vulnerabilities
 Financial corporates had the biggest annual jump in debt ratios in over a decade,
according to the IIF; It was the first year-over-year rise since 2016
 In emerging markets, South Africa and India had the biggest increases in government debt
ratios last year; Corporate debt accumulation was greatest in Peru and Russia
 Foreign-currency debt in the developing world lingered near $8.6 trillion in 2020 “as sharp
losses in EM currencies reduced firms’ incentives to borrow in foreign currency,” according
to the IIF
26

 ECONOMIC UNION
 A common market involving more than one nation based on a mutual agreement to permit the free
movement of capital, labor, goods and services. An economic union can also require the coordination of
various social, fiscal and monetary policies among participating nations.
 Purposes for establishing an economic union normally include increasing economic efficiency and
establishing closer political and cultural ties between the member countries.
 Economic union is established through trade pact.
 LIST OF ECONOMIC UNIONS
 European Union
 Benelux Union
 Belgium–Luxembourg Economic Union
 CARICOM Single Market and Economy
 Central American Common Market
 Eurasian Economic Union
 Mercosur
 de facto Switzerland–Liechtenstein
 Gulf Cooperation Council

27

 EUROPEAN COMMUNITY (EC)
 European Community (EC) was an economic association formed by six European member
countries in 1957, consisting of three communities that eventually were replaced by
the European Union (EU) in 1993. The European Community dealt with policies and governing,
in a communal fashion, across all member states.
 The six founded member countries of the european community were Belgium, Germany,France,
Italy ,Luxembourg & nertherlands.
 Goals of EC
 The primary goal of the European Community was to foster a common trade policy that would
eliminate trade barriers, thereby improving economic conditions for the entire region.
 Government officials from member states (who were well aware of the tensions still simmering in
the aftermath of World War II) wanted to promote a high level of integration and cooperation in
order to reduce the likelihood of future wars.
28

 The European Economic Community (EEC)
 The first of the three organizations in the European Community :
 European Economic Community (EEC), also known as the Common Market. The EEC was
established in 1957 by the Treaty of Rome as a way to unify the economies of Europe and
reduce tensions that could lead to war. Of particular concern was to promote a lasting
reconciliation between France and Germany.
 In order to eliminate trade barriers and implement unified trade policies, member countries
needed to cooperate politically and arbitrate differences peacefully. The benefit for all countries
would be the ability to engage in profitable trade across borders. In 1962, the EEC implemented
an agricultural policy that shielded EEC farmers from competition arising from agricultural
imports.
29

 European Coal and Steel Community (ECSC)
 The second organization in the European Community was the European Coal and Steel
Community (ECSC). It was put in place to attempt to regulate manufacturing practices across the
member states. By integrating the steel and coal industries in western Europe, the ECSC was
able to remove almost all trade barriers among member states in coal, steel, coke, scrap iron,
and pig iron.
 The ECSC set treaty rules regarding pricing and quotas, imposing fines on companies that broke
the rules. By the 1960s, trade in the commodities overseen by the ECSC had risen throughout
the region. The focus of the ECSC shifted in the 1970s toward reducing excess production in the
steel industry in order to maintain competitiveness as Japan flooded the markets with cheap steel
30

 European Atomic Energy Community
 Lastly, the European Atomic Energy Community (also known as "Euratom") was created in 1958
to establish a common market among member nations for trade in nuclear materials and
equipment. Among Euratom's goals was to coordinate research and promote peaceful uses for
atomic energy. The organization did not include military uses of nuclear materials as part of its
oversight. Instead, it focused on trade issues and establishing health and safety regulations for
atomic energy.
31

 Why do countries want to join the European Union?
 Citizens of the various countries enjoy the freedom to move to any of the EU member countries
without having to meet strict requirements. These citizens may move for the purpose of
employment, education or to set up a business.
 Another reason countries may wish to join the EU is that commodity prices are significantly
lowered. This is possible because the EU creates a single market for all members meaning
certain taxes are eliminated.
 Joining the EU gives countries a better platform to air their international concerns. Since member
countries work together in dealing with important issues, it is likely that the international
community will pay attention to the EU voice.
 Countries that are not well developed can benefit by joining the EU and receiving assistance with
regards to funding and logistics. This is usually done through the European Structural Fund.
 As countries join the EU, more jobs are created for the citizens. The issue of unemployment is
therefore effectively dealt with when a country is admitted into the Union.
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