Evaluate the measures that might be taken to reduce a deficit in the current account of the UK’s balance of payments. (25)

Question 1

Intro

Answer 1

• The balance of payments is the difference in total value between payments into and out of a country over a certain period.
• The current account is part of the balance of payments and can be split up into primary income, secondary income, and net trade.
• The UK has had a current account deficit since 1999.

Question 2

P1 - Devaluing the ER

Answer 2

• Devaluing the exchange rate (ER) can make exports relatively cheaper and imports relatively more expensive, improving net trade and the current account balance.
• The Marshall-Lerner condition requires the price elasticity of demand for exports and imports to sum to more than 1 for a devaluation in the currency to improve net trade.
• The J-curve shows a temporary worsening of the current account deficit, followed by an improvement in the long-term. Other currencies devaluing can decrease the effectiveness of this policy.

Question 3

P2 - Reducing Domestic Consumption

Answer 3

• Increasing income tax rates can reduce domestic consumption, which will reduce import spending and the growth of AD.
• However, this conflicts with other macroeconomic objectives, such as reducing inequality, and could lead to increased unemployment or economic inactivity.
• Tax rate increases are also very unpopular policies and could face retaliation from trade unions. This policy is likely not worthwhile if reducing the current account deficit is the main benefit.

Question 4

P3 - Protectionist Measures

Answer 4

• Protectionist measures, such as imposing tariffs on foreign goods, can reduce imports and potentially increase exports, improving net trade and the current account balance.
• Government revenue generated by tariffs can be used to fund supply-side policies to further reduce prices of domestic goods and increase international competitiveness.
• However, the effectiveness of tariffs can be compromised if other countries choose to retaliate with tariffs on UK goods.
• The implementation of tariffs or quotas can also lead to inefficiencies and government failure.

Question 5

Conclusion

Answer 5

• Decreasing the net trade deficit seems to be the most effective way to reduce the current account deficit.
• A devaluation of the pound and protectionist measures can be helpful, but the effectiveness of these policies can vary depending on how other countries respond.
• Contractionary fiscal policies, such as increasing income tax rates, are unlikely to be effective due to the potential negative impact on unemployment.
• No single policy in isolation can definitively improve the current account deficit.