AY 2021 2022 Final Module

AE – 12
ECONOMIC DEVELOPMENT
FINAL MODULE
This module is intended for 1st year students of Bachelor of Science in Accountancy
and Bachelor of Science in Accounting Information System in the CARD-MRI
Development Institute (CMDI), Inc. Tagum Campus
AE 12: Economic Development Module Content || Final
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Table of Contents
LEARNING OUTCOME: ............................................................................................. 3
ACTIVATE PRIOR KNOWLEDGE............................................................................ 3
Inflation, Monetary, Fiscal, and Incomes Policy .......................................................... 4
What is inflation? ...................................................................................................... 4
Types of inflation ...................................................................................................... 4
What is core inflation? .............................................................................................. 4
The Importance of Core Inflation............................................................................. 5
The Ratchet Effect .................................................................................................... 5
What is monetary policy? ......................................................................................... 5
Objectives of Monetary Policy ................................................................................. 5
Tools of Monetary Policy ......................................................................................... 6
Expansionary vs. Contractionary Monetary Policy ................................................. 7
What is fiscal policy?................................................................................................ 7
How Does Fiscal Policy Work? ............................................................................... 7
Two types of Fiscal Policy ....................................................................................... 7
Activity 10: Fiscal and monetary policy .................................................................. 8
What is Incomes Policy? .......................................................................................... 8
Criticism of incomes policy...................................................................................... 9
Balance of Payments, Aid, and Foreign Investment................................................... 10
Components of the balance of payment ................................................................. 10
Capital Inflows ........................................................................................................ 11
Sources of Financing the Deficit: Aid, Remittances, Foreign Investment, and
Loans ....................................................................................................................... 13
Activity 11: Impacts of Aid ......................................................................................... 14
The External Debt and Financial Crises...................................................................... 15
Debt Relief Measures (by: Aahana S) .................................................................... 16
External Debt Strategy (by: Aahana S) .................................................................. 17
What is a financial crisis? ....................................................................................... 17
What Are the Stages of a Financial Crisis?............................................................ 18
Financial Crisis Examples (by: Klenton, 2021) ..................................................... 18
Is financial crisis similar to economic crisis? ........................................................ 19
International Trade ....................................................................................................... 20
Comparative Advantage ......................................................................................... 20
Origins of Comparative Advantage........................................................................ 20
Free Trade vs. Protectionism .................................................................................. 21
Criticisms of Comparative Advantage ................................................................... 21
Other Possible Benefits of Trading Globally ......................................................... 21
ASSESSMENT 4: Finals ............................................................................................. 22
TIMELINE: .................................................................................................................. 23
REFERENCES ............................................................................................................ 23
CARD-MRI Development Institute, Inc. Modular Learning Page 2 of 23

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LEARNING OUTCOME:
After successful completion of this module, students are expected to be able to
discuss the important macroeconomic and international economics of development.
ACTIVATE PRIOR KNOWLEDGE

Before we embark on our new set of learning, let us have a short game! Below is the
crossword puzzle that you must fill up. These words are some of the terms that we
will be using in this module. Good luck and enjoy!

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Inflation, Monetary, Fiscal, and Incomes Policy

What is inflation?
Inflation is the rate of increase in the general level of prices, measured by the
consumer price index (CPI), the average price of a basket of goods and services
consumed by a representative household, or by the GDP deflator, which compares the
average price of the GDP basket today and in a base period.
Types of inflation
a) Demand–pull inflation results from consumer, business, and government
demand for goods and services in excess of an economy’s capacity to produce.
This increases demand and leads to price rises.
b) Cost–push inflation means prices increase even when demand drops or
remains constant, because of higher costs in imperfectly competitive markets.
We can also categorize inflation by how fast the price increases (Pettinger, 2019):
a) Creeping inflation (1-4% a year)
When the rate of inflation slowly increases over time. For example, the inflation
rate rises from 2% to 3%, to 4% a year. Creeping inflation may not be immediately
noticeable, but if the creeping rate of inflation continues, it can become an
increasing problem.
b) Walking inflation (2-10% a year)
When inflation is in single digits – less than 10%. At this rate – inflation is not a
major problem, but when it rises over 4%, Central Banks will be increasingly
concerned. Walking inflation may simply be referred to as moderate inflation.
c) Running inflation (10-20% a year)
When inflation starts to rise at a significant rate. It is usually defined as a rate
between 10% and 20% a year. At this rate, inflation is imposing significant costs
on the economy and could easily start to creep higher.
d) Galloping inflation (20%-1000% a year)
This is an inflation rate of between 20% up to 1000%. At this rapid rate of price
increases, inflation is a serious problem and will be challenging to bring under
control. Some definitions of galloping inflation may be between 20% and 100%.
There is no universally agreed definition, but hyperinflation usually implies over
1,000% a year.
e) Hyperinflation (> 1000% a year)
This is reserved for extreme forms of inflation – usually over 1,000% though there
is no specific definition. Hyperinflation usually involves prices changing so fast,
that it becomes a daily occurrence, and under hyperinflation, the value of money
will rapidly decline.
What is core inflation?
Core inflation is the change in the costs of goods and services but does not include
those from the food and energy sectors.

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Food and energy prices are exempt from this calculation because their prices can be
too volatile or fluctuate wildly.
The Importance of Core Inflation
It is important to measure core inflation because it reflects the relationship between
the price of goods and services and the level of consumer income. If prices for goods
and services increase over time, but consumer income doesn't change, consumers will
have less purchasing power. Inflation causes the value of money or income to decrease
in comparison to the prices of basic goods and services.
The Ratchet Effect
The ratchet effect refers to escalations in production or prices that tend to self-
perpetuate. Once productive capacities have been added, or prices have been raised,
it is difficult to reverse these changes because people are influenced by the prior
highest level of production or price (Barone, 2021).
A ratchet is a toothed wheel provided with a catch that
prevents the ratchet wheel from moving backward. The same
is the case under ratchet inflation when despite downward
pressures in the economy, prices do not fall. In an economy
having price, wage and cost inflations, aggregate demand
falls below full employment level due to the deficiency of
demand in some sectors of the economy.
But wage, cost and price structures are inflexible downward
because large business firms and labor organizations possess
monopoly power. Consequently, the fall in demand may not
lower prices significantly. In such a situation, prices will have
an upward ratchet effect, and this is known as “ratchet inflation.” (Chand, n.d.)
What is monetary policy?
Monetary policy is an economic policy that manages the size and growth rate of the
money supply in an economy. It is a powerful tool to regulate macroeconomic
variables such as inflation and unemployment. (CFI, 2021)
Objectives of Monetary Policy
The primary objectives of monetary policies are the management of inflation or
unemployment, and maintenance of currency exchange rates.
1. Inflation
Monetary policies can target inflation levels. A low level of inflation is considered to
be healthy for the economy. If inflation is high, a contractionary policy can address
this issue.
2. Unemployment
Monetary policies can influence the level of unemployment in the economy. For
example, an expansionary monetary policy generally decreases unemployment
because the higher money supply stimulates business activities that lead to the
expansion of the job market.
3. Currency exchange rates

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Using its fiscal authority, a central bank can regulate the exchange rates between
domestic and foreign currencies. For example, the central bank may increase the
money supply by issuing more currency. In such a case, the domestic currency
becomes cheaper relative to its foreign counterparts.
Tools of Monetary Policy
Central banks use various tools to implement monetary policies. The widely utilized
policy tools include:
1. Interest rate adjustment. A central bank can influence interest rates by changing the
discount rate. The discount rate (base rate) is an interest rate charged by a central bank
to banks for short-term loans. For example, if a central bank increases the discount
rate, the cost of borrowing for the banks increases. Subsequently, the banks will
increase the interest rate they charge their customers. Thus, the cost of borrowing in
the economy will increase, and the money supply will decrease.
2. Change reserve requirements. Central banks usually set up the minimum amount of
reserves that must be held by a commercial bank. By changing the required amount,
the central bank can influence the money supply in the economy. If monetary
authorities increase the required reserve amount, commercial banks find less money
available to lend to their clients and thus, the money supply decreases.
Commercial banks can’t use the reserves to make loans or fund investments into new
businesses. Since it constitutes a lost opportunity for the commercial banks, central
banks pay them interest on the reserves. The interest is known as IOR or IORR
(interest on reserves or interest on required reserves).
3. Open market operations. The central bank can either purchase or sell securities
issued by the government to affect the money supply. For example, central banks can
purchase government bonds. As a result, banks will obtain more money to increase
the lending and money supply in the economy.

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Expansionary vs. Contractionary Monetary Policy
Expansionary Monetary Policy
This is a monetary policy that aims to increase the money supply in the economy by
decreasing interest rates, purchasing government securities by central banks, and
lowering the reserve requirements for banks. An expansionary policy lowers
unemployment and stimulates business activities and consumer spending. The overall
goal of the expansionary monetary policy is to fuel economic growth. However, it can
also possibly lead to higher inflation.
Contractionary Monetary Policy
The goal of a contractionary monetary policy is to decrease the money supply in the
economy. It can be achieved by raising interest rates, selling government bonds, and
increasing the reserve requirements for banks. The contractionary policy is utilized
when the government wants to control inflation levels.
What is fiscal policy?
Fiscal policy is the use of government spending and taxation to influence the
economy.
How Does Fiscal Policy Work?
Proponents of Fiscal Policy utilization believe that public finance can influence
inflation and employment by manipulating two key variables:
1. The level of government spending or the amount of money the government
spends (includes subsidies, welfare programs, public works projects, and
government salaries)
2. The tax rate or the amount of money the government earns (includes
income, capital gains from investments, property, and sales tax)
Two types of Fiscal Policy
1. Expansionary Fiscal Policy
Expansionary fiscal policy is when the government expands the money supply in the
economy using budgetary tools to either increase spending or cut taxes—both of
which provide consumers and businesses with more money to spend. The government
either spends more, cuts taxes or both. The idea is to put more money into consumers'
hands, so they spend more. The increased demand forces businesses to add jobs to
increase supply (Amadeo, www.thebalance.com, 2020)
2. Contractionary Fiscal Policy
The second type of fiscal policy is contractionary fiscal policy, which is rarely used.
Its goal is to slow economic growth and stamp out inflation. The tools of
contractionary fiscal policy are used in reverse. Taxes are increased, and spending is
cut. (Amadeo, 2020)

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Activity 10: Fiscal and monetary policy

Please identify if the given scenarios are either fiscal or monetary, expansionary, or
contractionary, and its effect on interest rate and demand.
Scenario Fiscal or Expansionary or Increase or
Monetary Contractionary Decrease
BSP prints more Interest rate
money will…
The government will Aggregate
decrease the tax rate. demand will…
BSP increases interest Aggregate
rate demand will…
The Duterte Aggregate
administration’s build, demand will…
build, build program
What is Incomes Policy?

Incomes policies in economics are economy-wide wage and price controls, most
commonly instituted as a response to inflation, and usually seeking to establish wages
and prices below free market level.
Incomes policy is thus an adjunct to fiscal and monetary policy. It is sometimes
defined as a deliberate intervention of the government in the process of price
formation for labor and products aimed at preventing pretax money incomes from
rising faster than the growth of national income in real terms.

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One variant of incomes policy is "tax-based incomes policies" (TIPs), where a
government fee is imposed on those firms that raise prices and/or wages more than
the controls allow.
Some economists agree that a credible incomes policy (i) would help prevent
inflation; (ii) is less expensive (more efficient) than recessions as a way of fighting
inflation, at least for mild inflation; (iii) has the best chance of being credible and
effective for the sectors of the economy dominated by monopolies or oligopolies,
particularly nationalized industry, with a significant sector of workers organized in
labor unions.
Incomes policies have often been resorted to during wartime. During the French
Revolution, "The Law of the Maximum" imposed price controls (by penalty of death)
in an unsuccessful attempt to curb inflation, and such measures were also attempted
after World War II. Peacetime income policies were resorted to in the US in August
1971 as a response to inflation. The wage and price controls were effective initially
but were made less restrictive in January 1973, and later removed when they seemed
to be having no effect on curbing inflation. Incomes policies were successful in the
United Kingdom during World War II but less successful in the post-war era.
Criticism of incomes policy
Other economists argue that inflation is essentially a monetary phenomenon, and the
only way to deal with it is by controlling the money supply, directly or by changing
interest rates. They argue that price inflation is only a symptom of previous monetary
inflation caused by central bank money creation.
Also, when the price of a good is lowered artificially, it creates less supply and more
demand for the product, thereby creating shortages.
The Law of the General Maximum was instituted during the French Revolution on 29
September 1793, setting price limits and punishing price gouging to attempt to ensure
the continued supply of food to the French capital. It was enacted as an extension of the
Law of Suspects of 17 September and succeeded the Law of the Maximum of 4 May 1793,
which served a similar purpose.
The law actually exacerbated the problem on food supply, as the new price setting led to
many food producers lowering their production or halting altogether, while many of
those who continued to produce held onto their inventories, rather than sell at the legal
price, which was often below the cost of production. This led to continued food shortages
and recurring famines throughout the country. The Committee of Public Safety responded
by sending soldiers into the countryside to arrest farmers and seize their crops. This
temporarily alleviated the shortages in Paris, however, it led to shortages becoming more
intense in the rest of the country.
The General Maximum's economic impact was largely negative, as its efforts at price
control led to an overall decrease in food supply and prolonged famines in parts of the
country. The law amplified parts of the problem it was trying to solve. The political and
symbolic impact of the General Maximum were clear, as the harsh punishments enacted
upon those who breached the Maximum became a symbol of the Reign of Terror.

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Balance of Payments, Aid, and Foreign Investment
The balance of payments (also known as balance of international payments and
abbreviated B.O.P. or BoP) of a country is the difference between all money flowing
into the country in a particular period of time (e.g., a quarter or a year) and the outflow
of money to the rest of the world. These financial transactions are made by
individuals, firms and government bodies to compare receipts and payments arising
out of the trade of goods and services.
A balance of payments surplus means the country exports more than it imports. It
means that more funds (dollars) entered the country. Meanwhile, a balance of
payments deficit means the country imports more goods, services, and capital than
they export, which means that more funds fled from the country. The illustration
below illustrates the difference between the two (Amadeo, www.thebalance.com,
2020).
Components of the balance of payment
The balance of payments consists of two components: the current account and the
capital account. The current account reflects a country's net income, while the capital
account reflects the net change in ownership of national assets.
However, the The International Monetary Fund (IMF) use a particular set of
definitions for the BoP accounts, which is also used by the Organization for Economic
Co-operation and Development (OECD), and the United Nations System of National
Accounts (SNA). The main difference in the IMF's terminology is that it uses the term
"financial account" to capture transactions that would under alternative definitions be
recorded in the capital account. The IMF uses the term capital account to designate a
subset of transactions that, according to other usage, previously formed a small part
of the overall current account.

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The Philippines is using the same components based on IMF definitions. Thus, the
components that we will define in this module are the current account, financial
account, and capital account.
The current account shows flows of goods, services, primary income, and
secondary income between residents and nonresidents. The current account is
an important grouping of accounts within the balance of payments. Its
components are:
o The goods and services account. This account shows transactions
in goods and services.
o The primary income account. This account shows amounts
payable and receivable in return for providing temporary use to
another entity of labor, financial resources, or nonproduced
nonfinancial assets.
o The secondary income account. This account shows redistribution
of income, that is, when resources for current purposes are
provided by one party without anything of economic value being
supplied as a direct return to that party. Examples include
personal transfers and current international assistance.
The capital account shows credit and debit entries for nonproduced
nonfinancial assets and capital transfers between residents and nonresidents.
Nonproduced, nonfinancial assets consist of:
(a) natural resources;
(b) contracts, leases, and licenses; and
(c) marketing assets (and goodwill).
The financial account records transactions that involve financial assets and
liabilities and that take place between residents and nonresidents. The
financial account measures how the net lending to or borrowing from
nonresidents is financed. Entries in the financial account can be corresponding
entries to goods, services, income, capital account, or other financial account
entries. For example, the corresponding entry for export of goods is usually an
increase in financial assets, such as currency and deposits or trade credit.
Alternatively, a transaction may involve two financial account entries.
Sometimes, the financial account transaction involves the exchange of one
asset for another, for example, a bond may be exchanged for currency and
deposits. In other cases, the transaction may involve the creation of a new
financial asset and corresponding liability. (International Monetary Fund,
2009).
Capital Inflows
National-income equations show the relationship between saving, investment, and
exports minus imports of goods and services (that is, the international balance on
goods, services, and income) or capital inflows. National income, when calculated on
the expenditure side, is
Y = C + I + (X − M) eq.1

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where C = consumption, I = domestic capital formation (or investment), X = exports
of goods and services, and M = imports of goods and services.
Savings (S) is that part of national income that is not spent for consumption, viz.
S=Y–C eq.2
Hence
Y=C+S eq.3
Thus, national income is equal to
C + I + (X − M) = C + S eq.4
If we subtract C from both sides of the equation,
I + (X − M) = S eq.5
Subtracting X from and adding M to both sides results in
I = S + (M − X) eq.6
If M exceeds X, the country has a deficit in its balance on goods, services, and income.
It may finance the deficit by borrowing, attracting investment, or receiving grants
from abroad (surplus items). Essentially
M−X=F eq.7
where F is a capital import or inflow of capital from abroad. Substituting this
variable in Equation 7 gives us
I=S+F eq.8
Equation 8 states that a country can increase its new capital formation (or investment)
through its own domestic savings and by inflows of capital from abroad.
LDCs obtain a capital inflow from abroad when institutions and individuals in other
countries give grants or make loans or (equity) investments to pay for a balance on
goods and services deficit (or import surplus).
Foreign loans enable a country to spend more than it produces, invest more than it
saves, and import more than it exports. But eventually, the borrowing country must
service the foreign debt. Debt service refers to the interest plus repayment of principal
due in a given year.
It is typical for a newly industrializing country to encounter a growing debt. In fact,
the United States, from the Revolutionary War until after the Civil War, was a young
and growing debtor nation. It is borrowing from England and France to finance an
import surplus for domestic investments, such as railroads and canals. However, the
United States proceeded to a subsequent stage, mature debtor nation, 1874 to 1914,
when the economy’s increased capacity facilitated the export surplus to service the
foreign debt.

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Sources of Financing the Deficit: Aid, Remittances, Foreign Investment, and
Loans
a) Aid
Foreign aid is the donations of money, goods, or services from one nation to another.
Such donations can be made for a humanitarian, altruistic purpose, or to advance the
national interests of the giving nation. Aid can be between two (bilateral) or many
(multilateral) countries/institutions. Bilateral aid is usually tied aid (conditional aid)
is when recipients must purchase products/ services from the donor country.
Multilateral aid is usually untied aid that can be spent in any sector of the recipient
country (Murshed & Khanaum, 2014).
Official development assistance (ODA) is a term coined by the Development
Assistance Committee (DAC) of the Organization for Economic Co-operation and
Development (OECD) to measure foreign aid. The DAC first used the term in 1969.
It is widely used as an indicator of international aid flow. It includes some loans
The OECD defines ODA as flows of official financing administered with the
promotion of the economic development and welfare of developing countries as the
main objective, and which are concessional in character with a grant element of at
least 25 percent (using a fixed 10 percent rate of discount). By convention, ODA flows
comprise contributions of donor government agencies, at all levels, to developing
countries ("bilateral ODA") and to multilateral institutions. ODA receipts comprise
disbursements by bilateral donors and multilateral institutions. (OECD, Glossary of
Statistical Terms)
ODA needs to contain the three elements:
(a) undertaken by the official sector (official agencies, including state and local
governments, or their executive agencies)
(b) with the promotion of economic development and welfare as the main objective;
and
(c) at concessional financial terms (if a loan, having a grant element of at least 25
per cent).
This definition is used to exclude development aid from the two other categories of
aid from DAC members:
1. Official Aid (OA): Flows that meet conditions of eligibility for inclusion in
Official Development Assistance (ODA), other than the fact that the
recipients are on Part II of the Development Assistance Committee (DAC)
List of Aid Recipients.
2. Other Official Flows (OOF): Transactions by the official sector with
countries on the List of Aid Recipients which do not meet the conditions for
eligibility as Official Development Assistance or Official Aid, either
because they are not primarily aimed at development, or because they have
a grant element of less than 25 percent.
Examples:

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If a donor country accords a grant or a concessional loan to Afghanistan it is classified
as ODA, because it is on the Part I list. (See DAC List of ODA Recipient)
If a donor country accords a grant or a concessional loan to Bahrain it is classified as
OA, because it is on the Part II list. (Those that are not found in the DAC List of ODA
Recipient)
If a donor country gives military assistance to any other country or territory it is
classified as OOF, because it is not aimed at development.
Why give aid?
Aid may serve one or more functions: it may be given as a signal of diplomatic
approval, or to strengthen a military ally, to reward a government for behavior desired
by the donor, to extend the donor's cultural influence, to provide infrastructure needed
by the donor for resource extraction from the recipient country, or to gain other kinds
of commercial access. Countries may provide aid for further diplomatic reasons.
Humanitarian and altruistic purposes are often reasons for foreign assistance.
Activity 11: Impacts of Aid

What are the positive and negative impacts of aid? Provide an example or a case that
will support your claim.
b) Worker’s Remittances
A remittance is a transfer of money, often by a foreign worker to an individual in their
home country. Money sent home by migrants competes with international aid as one
of the largest financial inflows to developing countries. Workers' remittances are a
significant part of international capital flows, especially with regard to labor-
exporting countries.
According to the World Bank, in 2018 overall global remittance grew 10% to US$689
billion, including US$528 billion to developing countries. Overall global remittance
is expected to grow 3.7% to US$715 billion in 2019, including US$549 billion to
developing nations.
According to a World Bank Study, the Philippines is the second-largest recipient for
remittances in Asia. It was estimated in 1994 that migrants sent over US$2.6 billion
back to the Philippines through formal banking systems. With the addition of money
sent through private finance companies and return migrants, the 1994 total was closer
to US$6 billion annually.
Economic benefits for developing countries
- remittance flows are the second-largest source, behind FDI, of external funding
for developing countries.
- remittance receivers' higher propensity to own a bank account means that
remittances can promote access to financial services for the sender and recipient

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- remittances sent by migrants can potentially encourage domestic investment,
thus, fostering economic growth
- remittances are less volatile. The stability of remittance flows amidst financial
crises and economic downturns make them a reliable source of foreign exchange
earnings for developing countries
c) Foreign investment
A foreign direct investment (FDI) is an investment in the form of a controlling
ownership in a business in one country by an entity based in another country. It
includes "mergers and acquisitions, building new facilities, reinvesting profits earned
from overseas operations, and intra company loans". FDI is the sum of equity capital,
long-term capital, and short-term capital as shown in the balance of payments.
1. Loans
Another important source of financing a country’s deficit is through borrowing or
loans. In finance, a loan is the lending of money by one or more individuals,
organizations, or other entities to other individuals, organizations, etc. The recipient
(i.e., the borrower) incurs a debt and is usually liable to pay interest on that debt until
it is repaid as well as to repay the principal amount borrowed.
Government debt can be categorized as internal debt (owed to lenders within the
country) and external debt (owed to foreign lenders).
In the 1960s, the LDC balance on goods and services deficit was financed primarily
by flows from official or semiofficial sources in the form of grants, concessional
loans, and market loans. Private finance during the 1960s consisted mainly of
suppliers’ credits and direct foreign investment. Commercial bank lending increased
in the decade after 1967.
In 1944, 44 nations established the World Bank, envisioned primarily as a source for
loans for post–World War II reconstruction; and the IMF, an agency charged with
providing short-term credit for international balance of payments deficits. Neither
institution was set up to solve the financial problems of developing countries;
nevertheless, today virtually all financial disbursements from the World Bank are to
LDCs, and the IMF is the lender of last resort for LDCs with international payments
crises.
The External Debt and Financial Crises

External debt (or foreign debt) is the total debt which the residents of a country owe
to foreign creditors; its complement is internal debt, which is owed to domestic
lenders. The debtors can be the government, corporations or citizens of that country.
The debt includes money owed to private commercial banks, foreign governments, or
international financial institutions such as the International Monetary Fund (IMF) and
World Bank.
A country’s total external debt (EDT) includes the stock of debt owed to nonresident
governments, businesses, and institutions and repayable in foreign currency, goods,
or services. EDT includes both short-term debts, with a maturity of one year or less;
long-term debt, with a maturity of more than one year; and the use of IMF credit,

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which denotes repurchase obligations to the IMF. External debt includes public and
publicly guaranteed debt, as well as private debt (World Bank 1993i:ix, 158–159)
A debt crisis can occur if a country with a weak economy is not able to repay the
external debt due to an inability to produce and sell goods and make a profitable
return. If a nation is unable or refuses
to repay its external debt, it is said to “Sovereign default is a failure by a government
be in sovereign default. This can lead in repayment of its country's debts.”
to the lenders withholding future
releases of assets that might be needed by the borrowing nation. Such instances can
have a rolling effect. The borrower’s currency may collapse, and the nation’s overall
economic growth will stall.
Debt Relief Measures (by: Aahana S)
In order to tackle international debt crisis, some measures have been considered, as
follows:
1. Rescheduling of Debt
The conservative approach propagated by advanced countries is that the debtor
countries may be allowed the facility of rescheduling of debt. It involves the
postponement of interest and principal payments or the addition of arrears to the
capital. The problem, however, is too acute to be tackled through mere rescheduling.
2. Growth-Oriented Structural Economic Reforms
In the IMF-World Bank meeting in 1985, U.S. Treasury Secretary James Baker
announced a plan, referred to as Baker Plan. It emphasized the provision of new loans
of the amount of USD20 billion to the debtor countries over a period of three years,
provided they are willing to undertake growth-oriented structural economic reforms
in their respective countries. But Baker Plan was meant only for the debtor countries
in the Western Hemisphere and had only very limited applicability.
3. Debt Reduction Facility
A new facility of $ 100 million was set up by the World Bank in 1989. It was meant
to provide grants to poor countries carrying out structural adjustment programmes in
order to enable them to buy back or exchange their commercial debt for a relatively
small percentage of its face value. This facility was deficient in two respects. First,
only those debtor countries were eligible for it that had access to World Bank’s
International Development Association (IDA) assistance. Second, the maximum limit
of grants for a debt-ridden country was just USD10 million which was too low.
4. Debt Write-Off
The less-developed indebted countries had been demanding for long some measure of
debt write-off from the creditor countries. In this regard, the Brady Plan was put
forward in 1989. It dealt with mechanisms for reducing debt and debt servicing such
as debt buybacks, exchange of old debt for new collateral securities at a discount, and
exchange of old debts for new bonds at par value with reduced interest rates coupled
with policies to encourage foreign direct investment and repatriation of flight of
capital from debtor countries.

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The Commonwealth Finance Ministers meeting in Trinidad in 1990 proposed a plan
to write off two-thirds of the debt of the poorest countries amounting to $ 18 billion,
to extend the repayment period to 25
“A write-off is a reduction in the recorded amount
years, and to capitalise the interest
of an asset. A write-off occurs upon the
payments in the first five years. The
realization that an asset no longer can be
Paris Club in 1991 agreed to provide
converted into cash, can provide no further use
for a 50 percent reduction in the net
to a business, or has no market value.”
present value of the consolidated debt-
service payments on debt not
associated with official development assistance.
During the 1990s, it was observed that there was a fall in the Debt- GDP ratio and
debt-service ratio in many less developed countries. But overall debt had been
continuously increasing. There was also an accumulation of interest arrears. In this
connection, South Commission had observed, “Unless these arrangements involve a
substantial reduction in the net transfer of capital from developing to developed
countries, allowing vigorous growth to take place, they will do no more than add to
the debt burden for the future.”
External Debt Strategy (by: Aahana S)
To deal effectively with the problem of external borrowing, it is important to adopt
better economic and financial policies over a sustained period.
1. There should be sustained and rapid expansion of exports. If the growth rate
of exports remains higher than the growth rate of external debt, the ratio of
debt to exports will be brought down.
2. Greater emphasis should be placed on direct foreign investments. Such
capital inflows do not involve interest burdens.
3. The borrowed funds should be directed to such sectors or activities in which
the rate of return is higher than the global interest rates.
4. It is of utmost importance not to blow up the borrowed funds in
consumption. The return for money used in consumption is zero.
5. Devise ways and means to improve the efficiency of the private sector
industries.
6. There should exist a clearly defined set of legislative regulations upon the
borrowing authority in the country.
A widespread credit problem often led to a financial crisis.
What is a financial crisis?
A financial crisis is defined as any situation where one or more significant financial
assets – such as stocks, real estate, or oil – suddenly (and usually unexpectedly) loses
a substantial amount of their nominal value (CFI Education, Inc.)
Common examples of a financial crisis include financial market crashes – either
widespread or within specific industries – housing market crashes and bank runs.
What Causes a Financial Crisis?

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A financial crisis can be caused by many factors, maybe too many to name. However,
often a financial crisis is caused by overvalued assets, systemic and regulatory
failures, and resulting consumer panic, such as a large number of customers
withdrawing funds from a bank after learning of the institution's financial troubles.
What Are the Stages of a Financial Crisis?
The financial crisis can be segmented into three stages, beginning with the launch of
the crisis. Financial systems fail, generally caused by system and regulatory failures,
institutional mismanagement of finances, and more. The next stage involves the
breakdown of the financial system, with financial institutions, businesses, and
consumers unable to meet obligations. Finally, assets decrease in value and the overall
level of debt increases.
Financial Crisis Examples (by: Klenton, 2021)
Financial crises are not uncommon; they have happened for as long as the world has
had currency. Some well-known financial crises include:
• Tulip Mania (1637). Though some historians argue that this mania did not
have so much impact on the Dutch economy, and therefore shouldn't be
considered a financial crisis, it did coincide with an outbreak of bubonic
plague which had a significant impact on the country. With this in mind, it
is difficult to tell if the crisis was precipitated by over-speculation or by the
pandemic.
• Credit Crisis of 1772. After a period of rapidly expanding credit, this crisis
started in March/April in London. Alexander Fordyce, a partner in a large
bank, lost a huge sum shorting shares of the East India Company and fled
to France to avoid repayment. Panic led to a run-on English bank that left
more than 20 large banking houses either bankrupt or stopping payments to
depositors and creditors. The crisis quickly spread to much of Europe.
Historians draw a line from this crisis to the cause of the Boston Tea Party—
unpopular tax legislation in the 13 colonies—and the resulting unrest that
gave birth to the American Revolution.
• Stock Crash of 1929. This crash, starting on Oct. 24, 1929, saw share prices
collapse after a period of wild speculation and borrowing to buy shares. It
led to the Great Depression, which was felt worldwide for over a dozen
years. Its social impact lasted far longer. One trigger of the crash was a
drastic oversupply of commodity crops, which led to a steep decline in
prices. A wide range of regulations and market-managing tools were
introduced as a result of the crash.
• 1973 OPEC Oil Crisis. OPEC members started an oil embargo in October
1973 targeting countries that backed Israel in the Yom Kippur War. By the
end of the embargo, a barrel of oil stood at $12, up from $3. Given that
modern economies depend on oil, the higher prices and uncertainty led to
the stock market crash of 1973–74, when a bear market persisted from
January 1973 to December 1974 and the Dow Jones Industrial Average lost
45% of its value.

______________________________________________________________________
• Asian Crisis of 1997–1998. This crisis started in July 1997 with the collapse
of the Thai baht. Lacking foreign currency, the Thai government was forced
to abandon its U.S. dollar peg and let the baht float. The result was a huge
devaluation that spread to much of East Asia, also hitting Japan, as well as
a huge rise in debt-to-GDP ratios. In its wake, the crisis led to better
financial regulation and supervision.
• The 2007-2008 Global Financial Crisis. This financial crisis was the worst
economic disaster since the Stock Market Crash of 1929. It started with a
subprime mortgage lending crisis in 2007 and expanded into a global
banking crisis with the failure of investment bank Lehman Brothers in
September 2008. Huge bailouts and other measures meant to limit the
spread of the damage failed and the global economy fell into recession.
Is financial crisis similar to economic crisis?
Both financial and economic crisis are terms used in reference to poor economic
conditions. However, a financial crisis is a situation whereby the financial assets’
values fall rapidly in an economy and directly affects the financial and banking
sectors. On the other hand, an economic crisis is a situation whereby a country
experiences a sudden down-turn due to a financial crisis and directly affects all
economic activities in an economy. An economic crisis, however, impacts all
economic players in the long run and gives a clear picture of economic performance
(Njogu, 2019).
Characteristics Financial Crisis Economic Crisis
Definition is a situation whereby the is a situation whereby a
financial assets' values fall country experiences a sudden
rapidly in an economy downturn due to a financial
crisis.
Effects directly affects the financial directly affects all economic

and banking sectors. activities in an economy.
Contributing contributing factors to a contributing factors to an
factors financial crisis include economic crisis include
uncontrolled and unexpected high-interest rates, a
consumer behavior, decrease in consumer
regulatory and systemic spending, high
failures as well as high-risk unemployment rate and a
incentives. financial crisis.
Economic effect is a sub-selection of an gives a clear picture of
economic crisis. economic performance.

______________________________________________________________________
International Trade
International trade is the exchange of capital, goods, and services across international
borders or territories because there is a need or want of goods or services.
Economic theory indicates that international trade raises the standard of living. A
comparison between the performance of open and closed economies confirms that the
benefits of trade in practice are significant (Kling, 2019).
Different countries are endowed with different assets and natural resources: land,
labor, capital, and technology, etc. This allows some countries to produce the same
good more efficiently—in other words, more quickly and with less of a cost.
Therefore, they may sell it more cheaply than other countries. If a country cannot
efficiently produce an item, it can obtain it by trading with another country that can.
This is known as specialization in international trade (Heakal, 2021).
Comparative Advantage
England and Portugal have historically both benefited by specializing and trading
according to their comparative advantages. Portugal has plentiful vineyards and can
make wine at a low cost, while England is able to more cheaply manufacture cloth
given its pastures are full of sheep. Each country would eventually recognize these
facts and stop attempting to make the product that was more costly to generate
domestically in favor of engaging in trade. Indeed, over time, England stopped
producing wine, and Portugal stopped manufacturing cloth. Both countries saw that it
was to their advantage to stop their efforts at producing these items at home and,
instead, to trade with each other in order to acquire them (Heakal, 2021).
These two countries realized that they could produce more by focusing on those
products with which they have a comparative advantage. In such a case, the
Portuguese would begin to produce only wine, and the English only cotton. Each
country can now create a specialized output of 20 units per year and trade equal
proportions of both products. As such, each country now has access to both products
at a lower cost. We can see then that for both countries, the opportunity cost of
producing both products is greater than the cost of specializing (Heakal, 2021).
Origins of Comparative Advantage
The theory of comparative advantage has been attributed to the English political
economist David Ricardo. Comparative advantage is discussed in Ricardo's book “On
the Principles of Political Economy and Taxation” published in 1817, although it has
been suggested that Ricardo's mentor, James Mill, likely originated the analysis and
slipped it into Ricardo's book on the sly (Heakal, 2021).
The theory of comparative advantage helps to explain why protectionism has been
traditionally unsuccessful. If a country removes itself from an international trade
agreement, or if a government imposes tariffs, it may produce an immediate local
benefit in the form of new jobs. However, this is often not a long-term solution to a
trade problem. Eventually, that country will grow to be at a disadvantage relative to
its neighbors: countries that were already better able to produce these items at a lower
opportunity cost (Heakal, 2021).

______________________________________________________________________
Free Trade vs. Protectionism
International trade has two contrasting views regarding the level of control placed on
trade between countries.
Free trade is the simpler of the two theories. This approach is also sometimes referred
to as laissez-faire economics. With a laissez-faire approach, there are no restrictions
on trade. The main idea is that supply and demand factors, operating on a global scale,
will ensure that production happens efficiently. Therefore, nothing needs to be done
to protect or promote trade and growth because market forces will do so automatically
(Heakal, 2021)
Protectionism holds that regulation of international trade is important to ensure that
markets function properly. Advocates of this theory believe that market inefficiencies
may hamper the benefits of international trade, and they aim to guide the market
accordingly. Protectionism exists in many different forms, but the most common are
tariffs, subsidies, and quotas. These strategies attempt to correct any inefficiency in
the international market (Heakal, 2021).
Activity 12. Protectionism

Based on your own observations, what industry in the country that the Philippine
government should implement a protectionism approach? Why?
Criticisms of Comparative Advantage

Why doesn't the world have open trading between countries? When there is free trade,
why do some countries remain poor at the expense of others? There are many reasons,
but the most influential is something that economists call rent-seeking. Rent-seeking
occurs when one group organizes and lobbies the government to protect its interests
(Heakal, 2021).
Say, for example, the producers of American shoes understand and agree with the
free-trade argument—but they also know that their narrow interests would be
negatively impacted by cheaper foreign shoes. Even if laborers would be most
productive by switching from making shoes to making computers, nobody in the shoe
industry wants to lose their job or see profits decrease in the short-run (Heakal, 2021).
This desire could lead the shoemakers to lobby for special tax breaks for their products
or extra duties (or even outright bans) on foreign footwear. Appeals to save American
jobs and preserve a time-honored American craft abound—even though, in the long
run, American laborers would be made relatively less productive and American
consumers relatively poorer by such protectionist tactics (Heakal, 2021).
Other Possible Benefits of Trading Globally
International trade not only results in increased efficiency but also allows countries to
participate in a global economy, encouraging the opportunity for foreign direct
investment (FDI). In theory, economies can thus grow more efficiently and can more
easily become competitive economic participants (Heakal, 2021).

______________________________________________________________________
For the receiving government, FDI is a means by which foreign currency and expertise
can enter the country. It raises employment levels, and theoretically, leads to a growth
in the gross domestic product (GDP). For the investor, FDI offers company expansion
and growth, which means higher revenues (Heakal, 2021).
ASSESSMENT 4: Finals
Write your answers on a clean sheet of paper. Do not forget to write your name and
section. There is no need to re-write the questions.
Write only ‘T’ if the statement is True, and ‘F’ when the statement is False. There are
two sentences in each item. If you think that the two statements are true, write TT; if
you think both are false write FF; but if you think one is true and the other is false,
write TF or FT. Please remember that the first letter represents your answer in the first
sentence and the second letter for the second sentence. Thus, TF and FT are not the
same.
Item Statement 1 Statement 2
1. Inflation is the rate of increase in Inflation decreases the value of
the general level of prices. It has money.
two types: demand-pull inflation
and supply-push inflation.
2. Monetary and fiscal policies are Expansionary policies that increase
used to regulate inflation and aggregate demand are inflationary.
employment. The former is
concerned with the supply of
money in the economy while the
latter uses government spending
and taxation to influence the
economy.
3. A surplus BoP means that a The BoP has three important
country imports more than it components: asset, liabilities, and
exports. equity.
4. A country can increase its new The government borrowing money
capital formation through its own from BDO or BPI is a simple
domestic savings and by inflows example of external debt.
of capital from abroad.
5. If a nation is unable or refuses to RA 11203 or the Rice Tariffication
repay its external debt, it is said to Law is a form of protectionism.
be in a sovereign default.
6. Japan’s donation of five warfare Foreign aid is a donation that can be
plane to the Philippines is an in a form of money, goods, or
example of ODA (Official services from one country to
Development Assistance). another.

______________________________________________________________________
7. Central bank increasing the Central bank decreasing the reserve
interest rate is expansionary. requirement ratio for banks is
contractionary.
8. Incomes policy is an inflation Incomes policy is instituted by the
response that establishes wage government.
and price below the free market
level.
9. BoP’s capital account includes It is impossible for a country to
financial assets. spend more than what it produces.
10. International trade can help The theory of comparative
improve the standard of living. advantage has been attributed to the
English political economist, Adam
Smith.
TIMELINE:
Please be guided on the deadline of your activities and assessment.
Number of Activity Deadline
Activity 10: Fiscal and Monetary
Activity 11: Impacts of Aid
Activity 12: Protectionism
A4: Finals
REFERENCES
Aahana S. (n.d.). External Debt Problem: Magnitude, Causes & Reflief Measures. Retrieved
from https://www.economicsdiscussion.net/
Amadeo, K. (2020, August 19). Retrieved from www.thebalance.com:
https://www.thebalance.com/what-is-fiscal-policy-types-objectives-and-tools-
3305844
Amadeo, K. (2020, August 28). www.thebalance.com. Retrieved from
https://www.thebalance.com/expansionary-fiscal-policy-purpose-examples-how-
it-works-3305792
Amadeo, K. (2020, May 4). www.thebalance.com. Retrieved from
https://www.thebalance.com/what-is-balance-of-payments-components-and-
deficit-
3306278#:~:text=A%20balance%20of%20payments%20surplus,growth%20in%20t
he%20short%20term.
B2B. (2017, September 21). www.civilsdaily.com. Retrieved from
https://www.civilsdaily.com/types-of-inflation-demand-pull-cost-push-stagflation-
structural-inflation-deflation-and-disinflation/

______________________________________________________________________
Barone, A. (2021, February 23). www.investopedia.com. Retrieved from
https://www.investopedia.com/terms/r/ratchet-effect.asp
Braun, A. (1986, September). www.elibrary.imf.org. Retrieved from
https://www.elibrary.imf.org/view/IMF071/07845-9780939934751/07845-
9780939934751/ch01.xml?language=en&redirect=true
CFI. (2021). www.corporatefinanceinstitute.com. Retrieved from
https://corporatefinanceinstitute.com/resources/knowledge/economics/monetar
y-policy/
Chand, S. (n.d.). www.yourarticlelibrary.com. Retrieved from
https://www.yourarticlelibrary.com/inflation/inflation-meaning-causes-and-
effects-effects-of-
inflation/29293#:~:text=Ratchet%20Inflation%3A&text=In%20an%20economy%20
having%20price,some%20sectors%20of%20the%20economy.&text=In%20such%2
0a%20situation%2C%20pr
Heakal, R. (2021, February 18). www.investopedia.com. Retrieved from
https://www.investopedia.com/insights/what-is-international-trade/
IndianEconomy. (2017). www.lms.indianeconomy.net. Retrieved from
https://lms.indianeconomy.net/glossary/structural-inflation-2/
International Monetary Fund. (2009). Balance of payments and international investment
position manual. Washington, D.C: Internation Monetary Fund.
Klenton, W. (2021, March 15). www.investopedia.com. Retrieved from
https://www.investopedia.com/terms/f/financial-crisis.asp
Kling, A. (2019). www.econlib.org. Retrieved from
https://www.econlib.org/library/Enc/InternationalTrade.html
Murshed, M., & Khanaum, M. (2014). IMPACT OF FOREIGN AID IN THE ECONOMIC
DEVELOPMENT OF RECIPIENT COUNTRY. Journal of the Bangladesh Association of
Young Researchers, 2(1), 33-37.
Nafziger, E. (2006). Economic Development, 4th Edition. New York: Cambridge University
Press.
Pettinger, T. (2019, November 4). www.economicshelp.org. Retrieved from
https://www.economicshelp.org/blog/2656/inflation/different-types-of-inflation/

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AE – 12

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ACTIVATE PRIOR KNOWLEDGE

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Inflation, Monetary, Fiscal, and Incomes Policy

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Activity 10: Fiscal and monetary policy

What is Incomes Policy?

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Activity 11: Impacts of Aid

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The External Debt and Financial Crises

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Effects directly affects the financial directly affects all economic

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Activity 12. Protectionism

Criticisms of Comparative Advantage

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