Practise comparing expenditure-reducing, expenditure-switching, protectionist and supply-side policies for current-account imbalances and evaluating their time horizon and costs.
Why may a government seek to reduce a current account surplus on the balance of payments?
to lower inflation
to lower unemployment
to raise the economic growth rate
to raise the exchange rate
Fall in price of oil but Colombia can look forward to growth
Fig. 1: Colombia's growth and the oil price
Source: Thomson Reuters Datastream
Fig. 2: Colombian peso against the US dollar (peso per US\$), inverted scale
Over the past year, the halving of crude oil prices has hit Colombia and much of South America hard. Venezuela's economy, for example, is expected to shrink by this year. Colombia's national oil production was running at 1 million barrels a year, accounting for half of its exports and a fifth of government revenues. In Puerto Gaitan, which only a year ago was the centre of Colombia's oil industry, the town's population had tripled to 45000 in just a few years. Property prices had soared and hotels overflowed. Today, though, business profits have fallen, leading to a fall in spending by entrepreneurs. "For Sale" signs now hang over Puerto Gaitan's closed stores, car parks in shopping malls are empty and 10000 people have left the town. Towns throughout Colombia are experiencing similar problems.
Colombia's government is feeling the effects as well. Every US$1 drop in the oil price per barrel cuts an estimated US million from government revenues. As a result, the government has cut spending and raised taxes to keep its budget deficit down. More worryingly, the collapse in the price of oil has opened a large current account deficit equivalent to of national income. Yet not all is bleak. Colombia's economy is forecast to grow this year. And unlike in neighbouring Venezuela, where oil accounts for more than of exports, there is concern but no panic.
Firstly, the peso's depreciation could reverse Colombia's current account problems, boosting traditional exports such as coffee, textiles, car parts and flowers - if not to its immediate neighbours, then to the United States. Colombia produces oil, but it is not only an oil-producing country. Secondly, Colombia's government is having peace talks with Marxist rebels to end the country's five decades of unrest. The government's military expenditure will be reduced and estimates suggest that this 'peace dividend' could add as much as 2 percentage points to growth.
The fall in the value of the Colombian peso shown in Fig. 2 is expected to reduce Colombia's current account deficit.
Discuss any factors that will determine whether the fall in the value of the peso will have this effect.