Methods to Correct a Persistent Current Account Deficit and their Effectiveness (HL)

Methods to Correct a Persistent Current Account Deficit (AO2) (HL)

There are quite a few ways governments can correct persistent current account deficits. This includes:

• Expenditure switching: The government may decide to encourage consumers and businesses to buy domestic products over imports. This means they still spend money, but the deficit will be smaller. 

  • • This can for example be done by imposing tariffs, quotas, or subsidies, as well as devaluing the currency (makes foreign goods look more expensive)

• Expenditure reducing: The government may decide to impose measures meant to cut expenditure as a whole.

  • • This can be done by contractionary fiscal or monetary policy.

• Supply-side policies: The government may decide to improve the economy's export competitiveness instead, by investing in or deregulating industries. 

  • • This can for example be done by improving infrastructure, investing in education, and provide tax breaks for startups.

Effectiveness of Methods to Correct a Persistent Current Account Deficit (AO3) (HL)

• Expenditure switching:

  • • Many consumers may have preferences regardless of price, and may still choose to buy imported goods

    • The imposition of trade barriers such as tariffs and quotas may cause retaliations in other countries, decreasing exports

    • Devaluing the currency will mean important imported goods (such as oil and electricity) will be more expensive, causing inflation

• Expenditure reducing:

  • • Expenditure reducing policies basically aim to hurt the economy to decrease demand. This will decrease economic well-being and growth

• Supply-side policies: 

  • • It takes a very long time for its effects to show, and will not be very useful in the short run