9708 · 6.5
Policies to correct imbalances in the current account of the balance of payments — FAQ
Frequently asked questions for 9708 Policies to correct imbalances in the current account of the balance of payments. Direct answers first, then deeper explanation — then practise with marking.
Does a currency devaluation always fix a current account deficit?
No. Its success is not guaranteed. Firstly, the Marshall-Lerner condition must hold (PEDx + PEDm > 1). Secondly, the J-curve effect means the deficit will likely worsen in the short term before it improves. Thirdly, devaluation raises the price of imported raw materials, which can cause cost-push inflation, eroding the competitive advantage gained.
Are expenditure-reducing policies the best way to cut a deficit?
Not necessarily. While they can be effective in reducing import spending, they do so by slowing down the entire economy. This can lead to a recession, rising unemployment, and falling living standards. It is often described as 'curing the disease by killing the patient', highlighting a severe conflict with other major macroeconomic objectives.
Why isn't protectionism used more often if it reduces imports?
Protectionism is generally viewed as a poor long-term policy. It often leads to immediate retaliation from trading partners, who impose their own tariffs, potentially leading to a trade war where all countries lose. It also harms domestic consumers through higher prices and less choice, and it protects inefficient domestic firms from international competition, leading to a misallocation of resources.