11.1 Policies to correct disequilibrium in the balance of payments

The balance of payments records transactions between residents and the rest of the world. The current account covers goods, services, primary income and current transfers; the financial account records investment and other financial flows.

Exports and receipts are credits, while imports and payments are debits. In principle the accounts balance once financing and reserve changes are included, but measurement errors and timing create a statistical discrepancy.

A current-account deficit may be matched by net capital inflows or a fall in reserves. That financing identity does not say whether the position is healthy or sustainable.

The balance of payments is not only the trade balance, and “it balances” does not mean every account is zero.

Policies for a current-account deficit include demand reduction, supply-side competitiveness measures, exchange-rate adjustment, import controls, export promotion and measures affecting saving and investment.

A deficit caused by excess demand calls for a different response from one caused by weak productivity or a temporary investment boom. Each policy has effects on inflation, employment, growth, distribution and trading partners.

Tighter fiscal policy may reduce import demand during an overheating boom; improving port infrastructure may help a structural export problem without deliberately suppressing household demand.

Improving the current account is not automatically the highest macroeconomic priority, and reducing imports by making households poorer is not a cost-free success.

Expenditure-switching policies shift spending from imports toward domestic goods, often through depreciation or protection. Expenditure-reducing policies lower total domestic spending, often through contractionary fiscal or monetary policy.

Switching may improve net exports but can create imported inflation or retaliation. Reducing demand can cut imports but also lower output and employment. The elasticities, spare capacity and time horizon determine the result.

A depreciation may switch demand toward domestic exports; a tax rise may reduce spending on both domestic and imported goods. Combining them can address different mechanisms but increases trade-offs.

A fall in imports after a recession is not automatically a successful switching policy; distinguish changed composition from reduced total demand.