My understanding of it right now is that when a country experience a depreciation in exchange rate, in the short run there is a deterioration in the balance of payments because imports would be price inelastic for some goods or the country is tied into a contract so they have to keep buying. Furthermore exports might be price inelastic so there would be less demand in the short run till everyone accepts the prices.
In the long run all these factors become irrelevant and there would be a improvement in the current account because of this.
2 questions about this
1) Is everyone I said above correct?
2) How does the import factors become irrelevant in the long run? Contracts agreements may be very long right (must buy for 1-3 years? I have no idea im just roughly guessing the years sorry) .. once it finishes wont the country buy the goods again if they have high in-elasticity of demand.. so it would be like going in circles?
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- Thread Starter
- 13-04-2013 16:20
- 13-04-2013 16:36
1) No. BOP does not decerease. BOP is ALWAYS 0. Your current account deficit (If you have one) will worsen in the short run and improve in the long run provided the currency undergoes a Sharp Depreciation/Devaluation and the PED of Imports + PED of exports is greater than 1 [ PED(M) + PED(X) >1 ]. You're thinking along the right lines with the contract - in the SR PED(X) and PED(M) are inelastic because people may not be aware of price changes or will take time to switch from one product to another, and firms are unable to change their contracts.
2)Due to depreciation, the value of imports increases. Hence in there will be less imports since they're now more expensive.