A balanced current account is a key objective for economic stability. Persistent imbalances, such as deficits or surpluses, can disrupt trade, increase debt, and affect economic growth. This guide explores government objectives for current account stability and the role of fiscal, monetary, supply-side, and protectionist policies in addressing current account imbalances, with real-world examples and insights into their effectiveness.
Government Policy Objective: Stability of the Current Account
The primary objective of current account stability is to maintain sustainable levels of trade and financial flows.
Why It Matters:
Large deficits lead to excessive borrowing and reliance on foreign capital.
Persistent surpluses can reduce domestic consumption and strain trade partners.
Key Goals:
Correcting Deficits: Reduce imports and increase exports to narrow the trade gap.
Managing Surpluses: Increase domestic spending and imports to reduce trade tensions.
Policies to Correct Current Account Imbalances
2.1 Fiscal Policy
Governments use taxation and public spending to influence trade balances.
For a Current Account Deficit:
Reduce government spending or increase taxes to lower domestic demand, reducing imports.
Example: Austerity measures in Greece during the Eurozone debt crisis reduced imports by curbing domestic consumption.
For a Current Account Surplus:
Increase public spending on imports (e.g., infrastructure projects using foreign machinery).
Example: Germany could boost domestic demand to reduce its trade surplus.
Effectiveness:
Fiscal policy is most effective when trade imbalances are driven by excessive domestic demand.
2.2 Monetary Policy
Central banks adjust interest rates and money supply to influence trade flows.
For a Current Account Deficit:
Depreciate the currency to make exports cheaper and imports more expensive.
Example: The Bank of England's post-Brexit monetary easing helped boost UK export competitiveness.
For a Current Account Surplus:
Appreciate the currency to make imports cheaper and exports less competitive.
Example: China's gradual appreciation of the Yuan aimed to reduce its trade surplus.
Effectiveness:
Exchange rate adjustments can quickly impact trade balances but may lead to inflation or capital flight.
2.3 Supply-Side Policies
Supply-side policies address structural issues affecting export competitiveness and import reliance.
For a Current Account Deficit:
Improve productivity and innovation to make domestic goods more competitive globally.
Example: South Korea’s investment in technology and R&D bolstered its export sector.
For a Current Account Surplus:
Encourage domestic consumption and reduce reliance on exports.
Example: Japan’s policies to boost domestic demand after decades of export-led growth.
Effectiveness:
Supply-side policies are long-term solutions and require significant investment.
2.4 Protectionist Policies
Governments may impose trade barriers to limit imports and promote domestic production.
For a Current Account Deficit:
Introduce tariffs, quotas, or subsidies to reduce imports and boost exports.
Example: The US imposed tariffs on Chinese goods to reduce its trade deficit.
For a Current Account Surplus:
Reduce export subsidies or eliminate trade barriers to increase imports.
Example: The EU’s reduction in agricultural export subsidies to address global trade imbalances.
Effectiveness:
Protectionism can provide short-term relief but often leads to retaliatory trade wars and inefficiencies.
AD/AS Analysis of Policy Impacts
3.1 Impact of Policies on AD
Expansionary Policies: Increase aggregate demand (e.g., fiscal spending, monetary easing), boosting exports.
Contractionary Policies: Reduce aggregate demand (e.g., austerity, higher interest rates), lowering imports.
3.2 Impact of Policies on AS
Supply-Side Improvements: Shift LRAS outward by enhancing productivity and export competitiveness.
Diagram: Show the effects of fiscal and monetary policies on the AD curve and the long-term impact of supply-side policies on LRAS.
Applications of Current Account Policies
Crisis Management:
Short-term policies like fiscal adjustments address immediate trade imbalances.
Sustainable Growth:
Long-term supply-side reforms ensure competitiveness without over-reliance on protectionism.
Global Trade Relations:
Balanced current accounts reduce trade tensions and promote economic cooperation.
Exam Tip
Use real-world examples to illustrate the success or failure of policies.
Include diagrams showing AD/AS shifts or currency effects on trade flows.
Highlight the short-term and long-term impacts of each policy.
Conclusion
Policies to correct current account imbalances must balance short-term adjustments with long-term structural reforms. Governments use a mix of fiscal, monetary, supply-side, and protectionist measures to address deficits or surpluses. Understanding the nuances of these policies equips students to analyze trade dynamics and evaluate policy effectiveness.
Practice Questions: Current Account Policies
Define the current account and explain why persistent deficits or surpluses pose challenges for economic stability.
Using diagrams, analyze how fiscal policy can address a current account deficit.
Evaluate the effectiveness of supply-side policies in correcting a current account imbalance, citing real-world examples.
Discuss the potential trade-offs and risks associated with protectionist policies in addressing current account deficits.