Policies Which Stabilise the Current Account Balance
- The Government has several policies (fiscal, monetary & supply-side policy) available to them in order to address a current account deficit or to stabilise the current account balance. Overall, their choices are:
- They could do nothing, leaving it to market forces in the foreign exchange market to self-correct the deficit
- They could use expenditure switching policies. These include:
• Protectionist policies which raise the price of imports, so consumers switch to buying domestic goods
• Currency devaluation which makes the price of imports more expensive & so consumers switch to buying domestic products - They could use expenditure reducing policies. These include:
• Raising taxes which cause consumers to have lower disposable income & so they spend less on imports
• Raising interest rates which reduces the level of borrowing resulting in a fall in the level of imports - They could use supply-side policies. These include
• Investment in education which raises productivity making exports cheaper & more attractive
• Investment in infrastructure which lowers costs for firms making exports cheaper & more attractive
- The use of any policy - or any combination of policies generates both advantages & disadvantages
Advantages & Disadvantages of Policies Used to Tackle Current Account Deficits
Policy Option |
Advantage |
Disadvantage |
Do nothing |
Floating exchange rates act as a self-correcting mechanism. Over time a higher level of imports will end up depreciating the currency causing imports to decrease (they are now more expensive) & exports to increase (they are now cheaper). This improves the deficit |
There may be other external factors that prevent the currency from depreciating. It may take a long time for self-correction to happen & many domestic industries may go out of business in the interim. The longer it takes to self-correct, the more firms will delay investment in the economy |
|
Expenditure Switching |
This is often successful in changing the buying habits of consumers, switching consumption on imports to consumption on domestically produced goods/services. This helps improve a deficit |
Any protectionist policy often leads to retaliation by trading partners. This may consist of reverse tariffs/quotas which will decrease the level of exports. This may offset any improvement to the deficit caused by the policy |
Expenditure Reducing |
Contractionary fiscal policy invariably reduces discretionary income which leads to a fall in the demand for imported goods & improves a deficit |
Contractionary fiscal policy also dampens domestic demand which can cause output to fall. When output falls, GDP growth slows & unemployment may increase |
|
Supply-side |
Improves the quality of products & lowers the costs of production. Both of these factors help the level of exports to increase thus reducing the deficit |
These policies tend to be long term policies so the benefits may not be seen for some time. They usually involve government spending in the form of subsidies & this always carries an opportunity cost |
Exam Tip
The terms expenditure switching & expenditure reducing are not in your syllabus. They have been included as they clearly explain the intention of any fiscal, monetary or supply-side policy used to address imbalances in the current account. The policies aim to switch expenditure away from imports or to reduce expenditure on imports - both of which will help to lower any current account deficit.
