Policies to correct current account Flashcards
The effect of fiscal policy on the current account
To reduce demand for goods and services including imports, it could use contractionary fiscal policy, increasing income tax and reducing government spending.
If a government is seeking to reduce a current account surplus, it could use expansionary fiscal policy. Lower income tax and higher government spending on, for instance, state pensions will increase consumer expenditure.
Fiscal policies measures may alter a country’s current account position in the short term but are unlikely to be a long term solution.
Raising taxes may also have adverse side effects. They lower demand, which may increase unemployment and slow economic growth. Higher taxation can also create disincentive effects and so may reduce aggregate supply.
The effect of monetary policy on the current account
Changing the rate of interest to influence the current account position is a more complex process. If an economy has a low rate of inflation and a current account deficit, its central bank may reduce the interest rate in an attempt to put downward pressure on a floating exchange rate.
To reduec a current account surplus, a government may seek to increase consumer expenditure by using expansionary monetary policy. IN this case, it may raise the money supply and cut the rate of interest. It might also try to encourage an appreciation of the exchange rate.
Most monetary policy tools are not likely to be effective in reducing imbalances in the current account of the balance of payments in the long term. This is because they are unlikely to be tackling the structural weaknesses in the economy, such as low productivity, which are causing a current account deficit. They may also not have any long term effect on structural strengths, such as a high rate of innovation and ownership of scarce raw materials, which are causing a current account surplus.
The effect of supply side policy on the current account
Supply side policy tools may reduce a current account deficit by making domestic products more price competitive and by making domestic markets more attractive to invest in.
Increased spending on education and training and increased investment subsidies may also increase exports.
A skillful labour force and good quality capital equipment may also attract foreign multinational companies to set up a local branch in the country in expectation they will be able to produce good quality products at low cost.
Trade unions reform may enable domestic firms to work with more flexibility and so be more responsive to changes in demand.
Supply side policy may not be a quick way of correcting imbalances in the current account of the balance of payments. It is also designed to reduce a current account surplus as it seeks to increase the quantity and quality of the country’s resources. It does, however, have the potential to correct a deficit in the current account in the long run.
