Answer to Question #282472 in Macroeconomics for ABEX

Question

5. Consider two authorities: the Ministry of Finance (MOF) of Ethiopia,

and the National Bank of Ethiopia (NBE). Suppose these authorities

have two major policy goals namely internal balance and external balance.

(a) What are the major targets under the goals of achieving internal

and external balances?

(b) To achieve the two goals, at least two policy instruments are required. Suggest two policy instruments of achieving the goals of

internal and external balances.

(c) The assignment problem: Using the Swan diagram, demonstrate

and discuss the conditions under which each authority is assigned

to the particular policy goal.

Answer 1

a)     Major targets of achieving external and internal balances

External balance aims at maintaining the right amount of surplus or deficit in the current account while the internal balance aims at maintaining full employment and price stability.

b)     The two policy instruments that can be used are;

Monetary and fiscal policies

c)     Swan diagram

Monetary is adopted by the bank to control interest rates payable for short-term borrowings or the money supply in order to reduce inflation or interest rates to ensure price stability and the general stability of the country’s currency.

Fiscal policy on the other side it's applied by the government and relies on taxation, government spending, and borrowing as a means of controlling business cycles such as a recession.

These two can be explained using a Swan diagram as below. The two lines show the internal (Employment VS unemployment) and external (Current account deficit VS current account surplus) balances and the axes represent relatives domestic costs and fiscal deficit. The diagram evaluates the changes to the economy that result from policies affecting domestic expenditure or relative demand for foreign and domestic goods.