Policies to reduce a Current Account Deficit on the balance of Paymentst
A current account deficit occurs when the value of imports (of goods, services and investment incomes) is greater than the value of exports. (See: Causes of current account deficit)
Policies To Reduce A Current Account Deficit
1. Devaluation
This involves reducing the value of the currency against others. (e.g. selling pounds would cause the value of the Pound to falll)
· If there is a devaluation in the currency the price of importing goods increases and therefore the quantity demanded of imports falls.
· Exports will be become cheaper and there will be an increase in the quantity of exports
· Therefore we would expect a devaluation to lead to an improvement in the current account. However it does depend upon the elasticity of demand for exports and imports.
See also: advantages and disadvantages of devaluation.
The Marshall Learner Condition
This states that a devaluation will improve the balance on the current account,
on the condition that the combined elasticity’s of demand for imports and exports is greater than one.
· If (PED x + PED m > 1) then a devaluation will improve current account
· If (PED x + PED m > 1) then an appreciation will worsen current account
·This is because the effect on the current account depends on the total value and not just the quantity of exports.
The J Curve effect
In short term demand for imports and exports tends to be inelastic. Therefore, after a devaluation, the current account tends to get worse before it gets better. Over time, demand becomes more price elastic.
· Another problem with devaluation is that it can lead to imported inflation. This is a problem if it leads to cost push inflation. This means the improvement in the current account might only be temporary.
2. Deflation
If govt reduces AD by raising interest rates or increasing taxes then people will have less money to spend so they reduce consumption of imports.
· The UK has a high marginal propensity to import therefore a reduction in AD improves the current account significantly.
· Deflationary policies will also put pressure on manufacturers to reduce costs and this will lead to more competitive exports and so exports will increase
· The success of this policy depends on the elasticity of demand for imports
· However this policy will conflict with other macroeconomic objectives With lower AD, growth is likely to fall causing higher unemployment.
3. Supply Side Policies
These can improve the competitiveness of the economy and exporters, but this will take time to have effect. See: supply side policies
4. Protectionism
Increased tariffs of quotas will reduce imports and improve the current acc
However :
1) Protectionism leads to retaliation so exports will decrease
2) Domestic industries may become uncompetitive, because there is no incentive.
Revision Notes - Balance of Payments
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