When there is a
BOP disequilibrium, either by the market forces or policy measures for readjustments,
SWAN model is helpful.
Internal Balance looks forward to acquiring full employment with lowest possible inflation, whereas
External Balance looks towards a "No surplus - No deficit" position in the economy. Any point above the internal balance line (or curve) would have
inflation, and any point below it would have
unemployment. Similarly, any point above the external balance line (or curve) would depict a
surplus, and any point below it would depict a
deficit scenario. To cure the
Inflation, we would use
Contractionary monetary policy which would lower it down and bring the economy to an
equilibrium point. To curtail
Unemployment, we would use
Expansionary monetary policy which would do the same as above. In order to cure the
Current account deficit in the economy, we need to increase the exports by a
devaluation, that would, in turn, help in increasing the employment by creating more jobs. For
Current account surplus, we would
overvalue the currency so that the exports are diminished. The zone above the equilibrium point (the V - shaped) is called the "
Critical Zone" because the problem there would be very close to equilibrium. So a policy measure might just worsen the condition by taking, the economy, past the equilibrium point. ==References==