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The Government has several options available to them in order to tackle persistent current account imbalances
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They could do nothing, leaving it to market forces in the foreign exchange market to self-correct the deficit
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They could use expenditure-switching policies
- These aim to switch consumption from foreign goods to domestic goods and involve the use of protectionism (tariffs, quotas), or a devaluation of the currency under a fixed exchange rate mechanism
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They could use expenditure-reducing policies
- These aim to reduce aggregate demand in an economy and include policies such as contractionary fiscal or monetary policy
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They could use supply-side policies
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The choice of any policy, or any combination of policies, generates both costs and benefits
Costs & Benefits of Policies used to Tackle Current Account Deficits or Surpluses
Policy Option
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Benefits
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Costs
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Do nothing
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Floating exchange rates act as a self-correcting mechanism
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Over time, a higher level of imports will end up depreciating the currency, causing imports to decrease (they are now more expensive) and exports to increase (they are now cheaper)
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This improves the deficit
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There may be other external factors that prevent the currency from depreciating
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It may take a long time for self-correction to happen and many domestic industries may go out of business in the interim
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The longer it takes to self-correct, the more firms will delay investment in the economy
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Expenditure switching
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This is often successful in changing the buying habits of consumers, switching consumption on imports to consumption on domestically produced goods/services
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This helps improve a deficit
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Any protectionist policy often leads to retaliation by trading partners
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The retaliation may consist of reverse tariffs/quotas which will decrease the level of exports
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This may offset any improvement to the deficit caused by the policy
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Expenditure reducing
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Supply-side policies
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Improves the quality of products and lowers the costs of production
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Both of these factors help the level of exports to increase, thus reducing the deficit
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These policies tend to be long term, so the benefits may not be seen for some time
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They usually involve government spending in the form of subsidies and this always carries an opportunity cost
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