Expenditure (Current Account Deficit)

• Current account deficit

  A big issue in an economy
• Balanced trade

  Government objective to not have large current account deficits
• Policies available to governments to close a current account deficit

  • Expenditure reducing policies
  • Expenditure switching policies
• Expenditure reducing policies

  1. Reduce the amount of spending on imports in the economy

  2. Reduce aggregate demand

  3. Reduce incomes in the economy

  4. Reduce the marginal propensity to import
• Contractionary monetary and fiscal policies


  Shift aggregate demand to the left, make incomes lower in the economy, and thus reduce the marginal propensity to import
• Contractionary monetary policy


  • Raise interest rates
  • Reduce the money supply
• Contractionary fiscal policy


  • Reduce government spending
  • Increase taxation levels
• Reducing aggregate demand

  Closes the trade deficit and current account deficit
• There is a big conflict of objectives by reducing aggregate demand - it might close the current account deficit but reduce growth, increase unemployment, and cause a recession
• If the economy is already at full employment, reducing aggregate demand may not decrease incomes
• The marginal propensity to import may not be high, so expenditure reducing policies may not reduce import expenditure enough
• Expenditure switching policies

  1. Use protectionism to target certain imports and reduce import expenditure

  2. Switch spending from imports towards domestic goods and services
• Protectionism can lead to retaliation from trading partners, which can worsen the current account deficit
• Protectionism can be inflationary and reduce efficiency
• Weaken the exchange rate

  1. Imports become more expensive, exports become cheaper

  2. Reduce interest rates to incentivize hot money outflow

  3. Increase money supply through quantitative easing

  4. Sell domestic currency reserves
• Weakening the exchange rate is a protectionist measure that can lead to currency wars and retaliation
• Weakening the exchange rate can be inflationary from both demand-pull and cost-push factors
• The Marshall-Lerner condition must be satisfied for a weaker exchange rate to improve the current account deficit
• Supply-side policies

  Policies to boost the international competitiveness of exports through price or quality competitiveness
• Supply-side policies are long-run, costly, and may not guarantee success
• Supply-side policies need to be heavily targeted to the specific cause of the competitiveness issue
• The current account deficit is only a problem if it is greater than the annual rate of real GDP growth, as it indicates unsustainable borrowing