Policies to correct current account imbalances
Correcting a current account deficit
Three kinds of policy:
- expenditure-reducing — lower total demand (higher taxes/interest rates) → fewer imports. But slows growth and raises unemployment.
- expenditure-switching — move spending from imports to home goods (a tariff, or a lower exchange rate). But can cause retaliation or inflation.
- supply-side — raise home firms' competitiveness (skills, technology) → more exports. Works best long-run, but slow.
Practice
An expenditure-switching policy works by:
Expenditure-switching shifts demand toward home goods (tariff or lower exchange rate); expenditure-reducing cuts total demand.
Practice
A drawback of expenditure-reducing policy is that it:
Cutting demand reduces imports but also slows growth and raises unemployment.
Practice
Supply-side policies to raise competitiveness work best in the long run.
Improving skills and technology raises exports over time, but it is slow to take effect.
You've got it
Key idea
- expenditure-reducing: cut demand → fewer imports (but slows growth)
- expenditure-switching: tariff or lower exchange rate → buy home goods (but retaliation/inflation)
- supply-side: raise competitiveness → more exports (slow but lasting)