Policies to reduce a current account deficit Flashcards
What are the policies to reduce a current account deficit?
Devaluation
Reducing expenditure
Protectionism
Supply side policies
What is devaluation?
A deliberate policy of a government or central bank to decrease the exchange rate of the domestic currency
What is devaluation different from and why?
Different from depreciation which means there is a fall in the value of a current due to free market forces and not due to government policy
How could a government reduce the value of a currency?
By reducing interest rates
By selling domestic currency and buying foreign currency
By increasing the money supply
How does reducing interest rates reduce the value of a currency?
Less hot money arriving in country (demand related)
More consumption/borrowing by consumers, more imports (supply related)
What happens if a government devalues the domestic currency?
Price of exports will fall, Demand for exports will rise
Price of imports will rise, Demand for imports will fall
What does the effectiveness of the policy of devaluation depend on?
PED for imports and exports
Marshall Lerner condition
How could the government reduce growth of AD?
By using fiscal policy or monetary policy
e.g. Using fiscal policy - government could increase taxes or reduce government spending
Using monetary policy - government could raise interest rates
What would happen if there is a slower growth of AD?
Inflation would be lower
What would happen if domestic inflation is lower than inflation in the rest of the world?
Domestic goods become more competitive
Demand for exports will increase, demand for imports will fall
What happens if there is a slower rate of AD growth?
This will slow the growth of imports
If imports rise at a slower rate than exports then the current account deficit will increase
What are the costs of reducing growth of AD?
Greater levels of unemployment
Reduced living standards
When is it a benefit to reduce AD growth?
When there is inflation because economy is at full capacity
Why might raising interest rates to deflate economy be ineffective in reducing the current account deficit?
Attracts hot money, damages ability to export because currency rises in value
What is protectionism?
Policies aim to protect domestic producers by restricting the level of imports
(this may be achieved by using tariffs, quotas, exchange controls)
What are problems with using tariffs or quotes to restrict imports?
UK can’t do this as we are in EU customs union
Makes goods more expensive for consumers
Retaliation (trade war)
What do supply side policies do?
Aim to influence AS in economy
Aim to make domestic producers more competitive and increase demand for UK goods reducing the current account deficit
What are supply side free market policies?
Reduce income tax Reduce corporation tax Privatisation and deregulation Reduce minimum wage Reform benefits system Reduce trade union power
What are supply side interventionist policies?
Increase spending on education/training
Increase spending on infrastructure
Stricter government competition policy
Reduce geographical immobility of labour
What is an evaluation of policies to reduce current account deficit?
Government can’t use protectionist policies because member of EU and WTO
Government would not want Bank of England to devalue the pound as it could cause higher inflation
Government don’t want to deflate economy if it causes lower growth and higher unemployment
