Unit 6.5 - Policies correct imbalances in current account

• Current account


  The difference between a country's exports and imports of goods, services, and capital
• Government policy objective of stability of the current account

  • Aim: To achieve a balance of payment (export revenue equals import expenditure)
  • Short run: May welcome higher import expenditure on raw materials and capital goods. May also welcome a surplus to boost AD and provide funds to repay external debt
• Effect of the fiscal policy on the current account

  1. Deficit: Use a contractionary fiscal policy to decrease the deficit (↑T and ↓G) to reduce disposable income and reduce demands for imports

  2. Surplus: Use an expansionary fiscal policy to decrease surplus (↑G and ↓T) to lower tax and possible increase in state pensions could increase consumer expenditure on imports and divert exported goods to the domestic market
• Fiscal policy is likely to only assist in the short term
• Effect of the monetary policy on the current account

  1. Reducing the money supply may reduce growth in spending on imports (could be difficult to control)

  2. Changing the interest rate to influence the current account position is complex: If a country has low inflation and a current account deficit, a reduced interest could make it more competitive, but could also increase inflation. Increasing the interest may cut consumer expenditure, reducing demand for imports and reduce inflationary pressure, but could increase the exchange rate which would reverse the fall in demand for imports

  3. To reduce a surplus: expansionary policy by raising money supply and cutting the interest rate
• Monetary policies are not effective long-term policies (does not tackle structural weaknesses in the economy e.g. low productivity)
• Effect of the supply-side policy on the current account

  1. Deregulation and privatisation may make domestic markets more attractive (increased competition which keeps prices low and quality high)

  2. Spending on training or investment subsidies may increase exports - improved productive capacity which could decrease prices and attract MNCs

  3. Trade union reforms may improve a firm's flexibility and responsiveness - less industrial action / increased reliability
• Supply-side policies are not designed to reduce a surplus but can improve a deficit in the long run
• Effect of protectionist policy on the current account

  1. Used to encourage domestic purchasing e.g. tariffs, but needs to be high quality substitutes to work effectively

  2. Imposing tariffs against trading partners in a trade bloc is not an option

  3. Imposing tariffs against other countries is a risk as it provokes retaliation and reduces the pressure on domestic firms to become more efficient