Stabilisation Policies (Cambridge (CIE) O Level Economics)
Revision Note
Policies Which Stabilise the Current Account Balance
The Government has several policies (fiscal, monetary and supply-side policy) available to them in order to address a current account deficit or to stabilise the current account balance. Overall, their choices are:
They could do nothing, leaving it to market forces in the foreign exchange market to self-correct the deficit
They could use expenditure switching policies. These include:
• Protectionist policies which raise the price of imports, so consumers switch to buying domestic goods
• Currency devaluation which makes the price of imports more expensive and so consumers switch to buying domestic productsThey could use expenditure reducing policies. These include:
• Raising taxes which cause consumers to have lower disposable income and so they spend less on imports
• Raising interest rates which reduces the level of borrowing resulting in a fall in the level of importsThey could use supply-side policies. These include
• Investment in education which raises productivity making exports cheaper and more attractive
• Investment in infrastructure which lowers costs for firms making exports cheaper and more attractive
The use of any policy - or any combination of policies generates both advantages and disadvantages
Advantages and Disadvantages of Policies Used To Tackle Current Account Deficits
Policy Option | Advantage | Disadvantage |
|---|---|---|
Do nothing | Floating exchange rates act as a self-correcting mechanism. 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). This improves the deficit | There may be other external factors that prevent the currency from depreciating. It may take a long time for self-correction to happen and many domestic industries may go out of business in the interim. The longer it takes to self-correct, the more firms will delay investment in the economy |
Expenditure Switching | This is often successful in changing the buying habits of consumers, switching consumption on imports to consumption on domestically produced goods/services. This helps improve a deficit | Any protectionist policy often leads to retaliation by trading partners. This may consist of reverse tariffs/quotas which will decrease the level of exports. This may offset any improvement to the deficit caused by the policy |
Expenditure Reducing | Contractionary fiscal policy invariably reduces discretionary income which leads to a fall in the demand for imported goods and improves a deficit | Contractionary fiscal policy also dampens domestic demand which can cause output to fall. When output falls, GDP growth slows and unemployment may increase |
Supply-side | Improves the quality of products and lowers the costs of production. Both of these factors help the level of exports to increase thus reducing the deficit | These policies tend to be long term policies so the benefits may not be seen for some time. They usually involve government spending in the form of subsidies and this always carries an opportunity cost |
Examiner Tip
The terms expenditure switching and expenditure reducing are not in your syllabus. They have been included as they clearly explain the intention of any fiscal, monetary or supply-side policy used to address imbalances in the current account. The policies aim to switch expenditure away from imports or to reduce expenditure on imports - both of which will help to lower any current account deficit.
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