Development and Growth Constraints - External Shocks

Shocks are unexpected changes in the economy that can affect variables such as the rate of inflation and the growth rate of GDP. In an inter-connected global economy, events in one part of the world can quickly affect many other countries. For example, the global financial crisis (GFC) brought about recession in many countries and financial distress in many regions. It also led to a fall in FDI flows into poorer countries and increased pressure on governments in rich nations to cut overseas aid budgets.

Policies to absorb the effects of an economic shock

Not every country has the ability to respond quickly and effectively to external shocks. Much depends on how severely they are affected by economic events.

1. Floating exchange rates (i.e. is there scope for a depreciation?)
2. Freedom to set / adjust monetary policy when conditions change - does the central bank have autonomy to change interest rates or bring in unconventional policies such as QE?
3. Geographically and occupationally mobile / flexible labour force - a more flexible labour force helps an economy adjust to shocks that change the pattern of exports
4. Strong non price competitiveness of domestic businesses - this helps make demand and output more resilient to fluctuations in the global economy
5. A diversified economy that is not over reliant on a few sectors
6. Strong fiscal position (stabilisation funds) - e.g. strong finances give a government the scope to run a fiscal stimulus when aggregate demand falls