Question

Describe the balance of payments of how international transactions are calculated. What are the problems with focusing too much in the magnitude of trade deficits in goods and services? What additional economic measures should be taken into consideration to diagnose any economic problems?

Answer 1

Balance of Payments
Balance of Payments refers to the total inflow and outflow of foreign exchanges. Balance of payments includes balance of current account, balance of capital account and balance of financial account. These include the transaction of income, capital and financial liabilities from and to foreign banks. Balance of payments consists of the entire transactions which directly or indirectly influences the production and supply, investments etc. of a country.
Focusing too much in trade deficits could affect the level of imports trying to reduce the trade deficits of the country. An increased tariffs or excise duties could reduce the consumption of imports. But that may not encourage the exports or production with no change in export or production incentives. Reducing trade deficits could affect the level of consumption with reduced supply of goods. The risk of deadweight loss can happen due to too much focus in the trade deficit. Since the trade deficit can be reduced by imposing higher tariffs, the problems on exports and production may not be resolved. That can affect the growth of economy due to reduced consumption and further inefficiency in supply and demand.
Problems in the economy cannot be resolved only with policies adopted to manage the trade deficits. Rather than concentrating too much in trade deficits, stimulation in demand and consumption should be encouraged through production and supply incentives. Imports should be encouraged for goods that are cheaper than the domestic economy. That can increase the ability of the public to consume more with the benefit from cheap imports. That can stimulate the domestic production to supply more for meeting the demand. Monetary and fiscal policies can affect the economic situations and problems and to tackle them than concentrating the trade deficit alone.