Current account surplus/deficit - problems and solutions
1. It may still experience balance of payments problems (as in deficits or surpluses) as there could be, for instance, a gradual long term change. For instance, commodity prices have fallen to a great extent in the past 50 years. This will affect commodites-based economies and perhaps limit their export revenues en route to a current account deficit, since agricultural-based economies are usually also developing countries whom continuously have to import goods for infrastructural improvements.
2. Persistent current account deficit:
Some problems which may arise from a persistent current account deficit is that there would be an depreciation of the currency since imports>exports and thus, it implies that there is excess supply of the currency. In the case of a current account surplus, it would lead to an appreciation of the currency since exports>imports and thus, it implies that there is excess demand for the currency. Regardless, the depreciation of the currency could lead to problems for domestic producers and lead to cost-push inflation as the cost of imported materials has risen. Another problem is that usually, a current account deficit is funded by borrowing. This will accumulate debt and lead to high indebtedness and perhaps limit funds which could have been spent on the domestic country. Furthermore, if a country is unable to pay back loans in time, it will negatively influence their international credit ratings and make future loans unlikely, as foreign countries would not be incentivized to lend to countries whom are unable to pay back debts. Furthermore, a current account deficit implies a financial account surplus, which probably means that interest rates have to be set relatively higher than other countries to attract financial investment. High interest rates might serve to weaken the economy as it deters investment upon capital (domestically) and lead to higher marginal propensity to save rather than a higher marginal propensity to consume, which limits domestic consumption.
This is a preview of the whole essay
2. Persistent current account surplus:
Some problems which may arise from a current account surplus is that it will eventually lead to the appreciation of the currency since exports>imports and thus there is excess demand of the currency on the foreign exchange market. This will lead to reduced export competitiveness, which limits growth and perhaps also employment in export-oriented industries. This will be especially devastating for countries which rely upon secondary and tertiary exportation, as these goods and services have higher PEDs, which makes it susceptible to currency appreciation. Another problem which may arise from a current account surplus is the loss of savings, as a CAS is offset by a FAD. A FAD implies that there is greater outflow of funds rather than inflow of money, implying capital flight.
Expenditure switching policies are policies aimed to reduce current account deficits. ESP rely upon switching expenditure away from imports and to domestically produced goods, which can happen through the use of protectionist measures, such as tariffs, quotas, subsidies, increased administrative barriers and in an extreme case, embargoes.
Expenditure-reducing policies are policies aimed to reduce current account deficits. ERP is based on the idea that a current account deficit would be met with austerity measures stemming from contractionary fiscal and monetary policies which will reduce rate of economic growth and lower marginal propensity to import.
5a) A possible solution to reduce a current account deficit is limiting imports and to achieve this, a government can use protectionist policies. However, this will fuel political conflicts and also, lead to trade wars, which leads to a global misallocation of resources due to more inefficient production passed on to inefficient producers whom do not hold a comparative advantage.
6a) Policies which countries can use to increase exports to reduce a current account deficit include policies such as depreciating its exchange rate. A government can achieve this by lowering interest rates, which will lower demand for its currency on the foreign exchange market and thus, the exchange rate will depreciate. Furthermore, another possible policy is subsidize domestic firms; the provision of an export-subsidy, which is direct monetary aid to every unit of exports produced.
6b) Disadvantages of lowering interest rates is that there will be lower financial investment from abroad, which could hurt an economy, especially in the case of a developing country, which constantly needs savings in order to expand its economy. Furthermore, by lowering interest rates, banks will lose potential profits as the rate of return has decreased. Also, in the case of an export subsidy, it also implies that there is misallocation of global resources.