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    An economy is experiencing a balance of payments deficit and inflation. All other things being equal, which policy is most likely to reduce both the balance of payments deficit on current account and the rate of inflation?

    The answer is a fall in government spending.

    I thought it would be a reduction in the exchange rate but it isn't :/


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    (Original post by JodieW)
    An economy is experiencing a balance of payments deficit and inflation. All other things being equal, which policy is most likely to reduce both the balance of payments deficit on current account and the rate of inflation?

    The answer is a fall in government spending.

    I thought it would be a reduction in the exchange rate but it isn't :/


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    Take it step by step, if you want to reduce inflation, decreasing exchange rates will not help as this will increase exports (so helps the current account) BUT it increases AD and therefore inflation.

    Cuts in government spending decrease inflation (as AD falls due to the cuts - contractionary fiscal policy)
    Also cuts in government spending mean AD falls so demand for imports fall - more on this: http://www.tutor2u.net/blog/index.ph...-government-do

    I think the second point is a harder one but just knowing that cuts in government spending would reduce inflation should have got you the answer as the other options would most probably increase AD

    hope this helps
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    Ahh i did this question which i got wrong too!

    A reduction in the exchange rate will lead to an increase in inflation which i didnt read properly, and will only help the balance of payment.
    Reducing goverment spending reduces the amount of people's income due to benefits are such therefore they are able to spend less, meaning less inflation and less money spent on import goods.
    Basically making people poorer to reduce the pressures. When people are poor, inflation is low and the BoP is surplus/less deficit
 
 
 
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