6.5 Policies to correct imbalances in the current account of the balance of payments
- Syllabus
- 9708–2026–2027
- Topic
- 6.5
- Level
- AS
Learning objectives
Current-account stability means a sustainable external position
The objective of current-account stability is an external position that can continue without an abrupt financing or exchange-rate crisis and remains compatible with sustainable output, employment and prices. It does not require the account to equal zero every year.
| Persistent position | Why a government may be concerned |
|---|---|
| Deficit | Repeated borrowing or asset sales may raise foreign debt and debt-service costs, weaken confidence and put downward pressure on the currency; correcting it suddenly can reduce output and employment |
| Surplus | Strong net exports may add to AD and inflation, appreciate the currency, provoke trade tension, or signal weak domestic consumption and investment; reducing it can lower inflationary pressure |
Judge an imbalance by its size and persistence, its cause, how it is financed, debt-service capacity and future export income. A temporary deficit financing productive investment can be more sustainable than one financing repeated consumption; a temporary commodity-led surplus need not justify immediate correction.
A deficit is not automatically bad and a surplus is not automatically good. The policy objective is sustainable stability while balancing growth, employment and inflation—not forced annual equality.
Trace four policy routes to the current account
For each policy, write a complete chain: instrument → domestic expenditure or productive competitiveness → demand for imports and/or exports → current-account balance. Then test time, elasticities, side effects and the original cause of the imbalance.
| Policy for a deficit | Main transmission to the current account | Main limits or conflicts |
|---|---|---|
| Contractionary fiscal: higher taxes or lower government spending | Disposable income/AD falls → household and firm spending, including imports, falls → deficit may narrow | Lower output and employment; import response depends on marginal propensity to import; budget measures may have lags |
| Contractionary monetary: higher interest rates or tighter credit | Borrowing and spending fall → import demand falls | Higher rates may appreciate the currency, making exports dearer and imports cheaper; investment, growth and employment may fall |
| Supply-side: education/training, infrastructure, competition, deregulation or investment incentives | Productivity rises and unit costs fall → domestic goods become more competitive → exports rise and import substitution may increase | Usually slow, uncertain and costly; success depends on firms expanding supply and foreign demand |
| Protectionist: tariffs, quotas or other import restrictions; export support | Imports become dearer or restricted and/or exports become more competitive → net exports may rise | Inelastic import demand, higher input/consumer prices, inefficiency, fiscal cost, evasion and retaliation against exports can offset the gain |
To reduce a surplus, reverse the expenditure direction: expansionary fiscal or monetary policy can raise domestic spending and imports. Measures that appreciate the currency can make exports less competitive and imports cheaper. Removing protection or export support may also reduce the surplus, but each choice affects inflation, growth and employment.
Choose by cause and horizon. Demand restraint fits an import-heavy spending boom and can work relatively quickly; supply-side policy better addresses weak productivity but takes time; protection can cut selected imports quickly but risks retaliation. Effectiveness depends on export/import PED and PES, spare capacity, import content, exchange-rate reactions, trading-partner growth and whether policies are combined.
No instrument guarantees correction. A tariff can raise import expenditure when demand is very inelastic, and higher interest rates can reduce imports yet worsen export competitiveness through appreciation. Compare the net effect and macroeconomic trade-offs before concluding.