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Policymakers have two major areas to work on in case of an open economy which are maintaining internal and external balance

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Policymakers have two major areas to work on in case of an open economy which are maintaining internal and external balance. Any unpredictable event has unseen consequences for the economy and it might have very severe outcomes which might be catastrophical. This is the Swan analysis in economics.

Internal balance of an economy is maintained when it is at full employment, i.e all the factors are working to their fullest potential. External balance, on the other hand is maintained when the current account deficit or surplus is not too much. These internal and external balances can be reached with the help of expenditure changing and expenditure switching policies respectively.

Expenditure changing policy is in the context of maintaining the current account balance where the country aims to employ its factors of production in full potential and in turn influence aggregate demand of the economy. The multiplier of fiscal policy is smaller in an open economy than in a closed economy.Crowding out of private investment is common in this case. On the monetary side, this policy leads to a fall in net exports as it leads to a reduction in interest rate.

Expenditure switching policy is mainly focused on maintaining the currency with tools like devaluation and revaluation. However the extent to how far these tools work depend on lot of factors like aggregate demand, elasticities etc. The policy makers should be able to tell when which policy is required and implement it for efficiency and effective outcomes.

For example: if there is a defationary gap in a country, while current account is balanced, a devaluation would lead to changes in current account. Therefore in this case along with expenditure switching, expenditure changing is also required.

Both policies should work together for the country to be in a balanced state both externally and internally.