Question

Elaborate on the policies to improve a secular current account deficit.

Answer 1

A current account deficit arises when the price of imports is higher than the value of exports (of goods / services / inv. income). Current account deficit reduction policies include: exchange rate devaluation (making exports cheaper –imports more expensive) Reducing domestic consumption and import spending (e.g. tight fiscal policy / higher tax) Supply side policies to improve domestic production and exports competitiveness.

1. Devaluation This means reducing the currency's value compared to others. (e.g. selling pounds would cause the value of the pound to fall) If the currency is devalued, the price of the imported goods will rise and therefore the quantity demanded of the imported goods will fall.
Exports will become cheaper and the quantity of exports will increase.
Therefore, if demand is fairly cost elastic, we would expect a devaluation to lead to an increase in (X-M) and hence the current balance of payments account.
It does, however, depend on the elasticity of export and import demand.

2. Monetary policy That interest rates are involved in tight monetary policy. Higher interest rates would increase debt and mortgage servicing costs, allowing people to spend less money. This will also increasing their import intake, improving the current account.
Higher interest rates will also lead to a decline in AD and thus a decrease in economic growth. This will reduce inflation and increase the competitiveness of UK exports.
Deflationary policies will also put pressure on producers to cut costs, leading to more competitive exports, and because of this impact, exports may increase over the long term.

3. Supply side policies Supply side policies can improve the economy's competitiveness and increase the attractiveness of exports. This may improve the current account position, but it may take a long time to have an effect.
For example, if the government pursued a privatization and deregulation policy, due to the profit motive in the private sector, it may help to increase the efficiency of the economy. This increased efficiency would result in lower production costs and increased exports.

4. Lower wages A tactic used by many countries in the Eurozone facing a significant current account deficit (but unable to devalue within the single currency) is to lower wages. Lower wages can reduce production costs and improve productivity. Lower wages, however, will also result in lower aggregate demand and may result in inflation and low growth.
If the government cut salaries from the public sector, it may have minimal impacts on export competitiveness.
Often known as internal devaluation is the lowering in wages.