Expenditure switching policies

An expenditure switching policy is any action taken by a government that is designed to persuade purchasers of goods and services both at home and abroad to buy

more of that country’s goods and services and
less of the goods and services of other countries.

Direct controls

Direct control is an example of expenditure-switching policies and affects the balance of payments by changing the relative price of home-produced and foreign goods.

Direct controls involve imposing quotas or even outright bans (embargoes) on imports.

These directly cut or prevent expenditure on imports and, as a result, people switch their spending from foreign to home-produced goods.

A government may impose a tariff or increase an existing tariff on imports.

This will encourage domestic consumers and firms to switch to buying domestic products.

Limitation: Imposing tariffs may provoke retaliation and reduce the pressure on domestic firms to become more efficient.

Monetary policy

A government may decide to alter its exchange rate as an expenditure switching measure.

If an economy is experiencing a current account surplus and has a fixed exchange rate, the government may decide to revalue its currency.

Raising the foreign exchange rate will raise export prices and lower import prices.

In the case of a current account deficit, a government may consider devaluing the currency.

In this case, export prices will fall and import prices will rise.

Limitation: Lowering the exchange rate will not work if demand for exports and imports is price inelastic or if the relative quality of the country’s products falls.