A government can reduce a current account deficit by lowering the exchange rate, cutting spending on imports, raising competitiveness or using protection.
Exchange rate: a lower exchange rate makes exports cheaper and imports dearer. Exports rise and imports fall, so the deficit narrows. But dearer imports can push up prices.
Fiscal and monetary policy: higher taxes, less government spending or higher interest rates cut total spending, including spending on imports. But they also slow growth and can cost jobs.
Supply-side policy: training, new machines and better technology help firms make better goods at lower cost, so exports sell better. This lasts longest, but it takes years.
Protection: tariffs and quotas cut imports. But they raise prices, other countries may hit back, and local firms do not get any better. To reduce a surplus, the same tools can be used the other way round.
- Exchange rate
- Lower rate: exports cheaper, imports dearer; risks inflation.
- Fiscal / monetary
- Reduce spending on imports; slows growth.
- Supply-side
- Raise competitiveness; slow but lasting.
- Protection
- Cuts imports; higher prices and retaliation.
Worked example: Choosing a policy for a deficit
A country has a large, lasting current account deficit because its exports are uncompetitive.
- Quick fix: allow the currency to depreciate, making exports cheaper.
- Risk: imported food and fuel become dearer, raising inflation.
- Lasting fix: supply-side policies to raise productivity and quality.
- Avoid relying on tariffs: they may lead trading partners to retaliate.
Watch out for this
Cutting imports is the only way to reduce a current account deficit.
Raising exports, through a lower exchange rate or more competitive firms, can also reduce the deficit, and is usually less harmful.
Check your understanding
Which policy is most likely to reduce a current account deficit in the long run without harming trading partners?
- Supply-side policies to raise productivity and export quality
- A tariff on all imports
- Cutting interest rates