Current Account of the Balance of Payments
International Trade & Globalisation
A government worried about a large current-account deficit (or an excessive surplus) can use several policies. They aim either to switch spending away from imports and toward exports, or to reduce total spending.
- Trade restrictions. Tariffs and quotas on imports reduce import spending and protect the trade balance, but trading partners may retaliate and reduce the country's exports, so the gain may be smaller than hoped.
- Allowing or encouraging a lower exchange rate. A depreciation makes exports cheaper abroad and imports dearer at home, narrowing a deficit, though it also raises import prices and can add to inflation.
- Reducing total demand (contractionary fiscal or monetary policy). Higher taxes or interest rates cut spending, including on imports, but this also slows growth and can raise unemployment.
- Supply-side policies. Improving productivity, skills and quality makes a country's goods more competitive, raising exports and reducing imports over the long run. This avoids the costs of the other policies but works slowly.
Common exam question
Which policy cuts a current account deficit
Question: Choose the policy most likely to reduce a current account deficit (1 mark, multiple choice).
The keyed option either cuts spending on imports or makes exports more competitive: letting the currency depreciate, tightening an import quota, or spending on infrastructure that raises productivity. Set in 3 of the 13 multiple-choice papers.
The wrong options mostly push the balance the other way: cutting income tax (more spending, some of it on imports), removing or cutting tariffs, and cutting subsidies to exporters or to domestic producers. Read the verbs closely: lowering a quota lets fewer imports in, while lowering a tariff lets more in. One item set a higher interest rate beside the productivity measure, and the productivity measure was keyed; a higher rate does cut spending at home, but it also tends to push the currency up, which makes exports dearer.
Most governments combine measures: demand-side or exchange-rate policy for a quick effect on the deficit, and supply-side policy to improve competitiveness over time. Each policy has a cost (retaliation, inflation, slower growth or a long time-lag), so the right choice depends on why the imbalance exists and how urgent it is.