Conditions for equilibrium

Conditions for equilibrium

In economics the essential meaning of equilibrium is balancing opposite forces.In the context of balance of payments, there is equilibrium when the nation’s economy is in basic adjustment to the rest of the world.Using balance of payments terminology, this state means that the aggregate of receipts transactions equals the aggregate of payments transactions.

The concept of balance of payments equilibrium is closely tied to how free markets interact.Departures from the operation of free and competitive market systems raise a question of whether an equilibrium condition exists.When balance of payments receipts and payments are equal, but under conditions where markets are not free and competitive, we cannot conclude there is equilibrium in the balance of payments.From a balance of payments perspective, governments tend to interfere with markets in at least two fundamental ways:

1.Governments may restrict domestic economic activity to achieve a better overall balance on external accounts.We refer to this restriction as the unemployment effect.

2.Governments may place quotas or tariffs on merchandise imports to improve the overall balance of payments performance.We refer to this action as the controls effect.

We have seen that at least three requirements must be met before a country’s balance of payments is in equilibrium.First, the total of basic or official settlements receipts and payments transactions must be in balance.This function could be interpreted to mean that there is a zero or close to zero balance in basic or official settlements transactions.Second, the domestic economy must be at full employment.It should be clear that a nation can “force” its balance of payments into what appears to be equilibrium.This circumstance could be accomplished through policies aimed at compressing domestic demand leading to high and unacceptable levels of unemployment of domestic resources (labor and capital).Third, the country should allow all sectors to operate on the basis of free and competitive markets.Any serious interference with the free operation of markets can be interpreted as a departure from balance of payments equilibrium.This interference can take the form of controls on payments, imports, or foreign investment flows, or restrictions on any type of international transaction.