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Policies to Correct Current Account Imbalances
- 1. Policies to Correct Current Account Imbalances Upper6th Macro International Economics
- 2. Expenditure Reducing Policies Policies to CorrectCurrent Account Imbalances Mr O’Grady
- 3. Expenditure Reducing Policies Definition:Expenditure-reducing policies relate to measures designed to reduce Aggregate Demand. As a result people will have lower incomes and spend less on imports Should be effective as there is high YED for imports Policy Examples: Contractionary Fiscal Policy: Cuts to government spending and increases in taxes Falling G cuts AD directly as it is a component Higher taxes will mean less disposable income for consumers, cutting C, and lower levels of retained profit for firms, cutting I Lower disposable incomes, less spent on imports Deflationary Monetary Policy: Increased rate of interest/reduction in the money supply This increases the cost of borrowing and the return of saving Households will cut back on C, firms will cut back on I Lower disposable incomes, less spent on imports Conflicting Objectives: In reducing AD, spending on all domestic goods also decreases, which could cause unemployment and a fall in economic growth
- 4. Expenditure Switching Policies Policies to CorrectCurrent Account Imbalances Mr O’Grady
- 5. Expenditure Switching Policies Definition:Expenditure-switching policies are measures to encourage people to buy domestic goods rather than imports M should fall whilst X remains constant – improving CA balance Policy Examples: Protectionist measures: Implementation of restrictions on trade in G&S between countries Tariffs: Taxes on imports, making them comparatively more expensive than domestic products Quotas: Limits on the amount of imports that can come into an economy Should directly restrict M Currency Devaluation: The deliberate downward adjustment in the official exchange rate. This will makes exports cheaper and imports more expensive M should fall and X should rise Requires a fixed exchange rate regime Marshall Lerner Condition: The sum of the price elasticities of imports and exports must be greater than one, │PEDX│ + │PEDM│ > 1, (i.e. elastic) if a currency devaluation is to have a positive impact on the CA. Otherwise, the value of (X-M) won’t increase despite the volume of (X-M) rising Retaliation: These policies may lead to retaliation by foreign governments, causing exports to also fall so that the current account deficit may not be corrected.
- 6. Supply Side Policies Policies toCorrect Current Account Imbalances Mr O’Grady
- 7. Supply Side Policies Definition:Policies to improve the costs/quality of domestic products and therefore competitiveness, boosting export demand X will rise, whilst M should fall (or at least remain constant) – improving CA balance Policy Examples: Productivity and efficiency: Policies designed to improve the quality and/or price of domestic goods The competitiveness of exports rises, boosting export demand. E.g. Increased education & training, improved competition policy, infrastructure projects Whilst they can incur an opportunity cost, they contribute positively to economic growth and can be anti- inflationary in the long run Refocusing: Policies which identify and encourage industries able to exploit opportunities in export market overseas Resources are focussed on industries where the UK has a real comparative advantage, accepting though that some industries should shrink or even close However: This will be politically unpopular and will cause job losses in the short term
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