Q&A: To correct a large current account deficit what can the government do?

To correct a large balance of payments current account deficit what can the government do?

Current account deficits are back in the news again as trade imbalances within the world economy have widened in recent years. Spain for example has run a current account deficit of more than 10% of her GDP in 2008. There are many options open to the government should it decide that the current account deficit needs to be reduced.

Some policies can be called “expenditure-switching” policies and are designed to change the relative prices of exports and imported goods and services and cause consumers to change the pattern of their spending e.g. make exports cheaper in an overseas market and make imports more expensive in the home (domestic) market.

*A depreciation of the exchange rate
*Export subsidies
*Import tariffs
*Policies to lower the rate of inflation in the home economy

Other policies might be called “expenditure-reducing” policies – designed to reduce aggregate demand and therefore lower the demand for imports

*Higher taxation
*A fall in government spending
*A rise in interest rates or a fall in the availability of credit

Another approach is to try to improve the supply-side of the economy

Some of these policies are discussed in our new revision presentation on adjustment policies for the Balance of Payments. Please have a look at this, it may be some help.

Remember to include some evaluation in your answer – which policies are likely to be most effective in reducing a deficit over a number of years? What are the costs and benefits of each of these policies for other macroeconomic objectives such as economic growth and unemployment?