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While current account deficits are a common economic challenge, there are several different ways in which can be employed to address them:
Methods of reducing a current account deficit:
- Devaluation - Lowering the value of the pound can make exports cheaper and imports more expensive. This can potentially increase export demand and reduce import demand.
- Deflationary policies - Can help reduce a current account deficit by cooling down the economy and reducing spending on imports. These policies mainly involve monetary and fiscal approaches:
- Monetary - This involves controlling money through interest rates. When the central bank raises interest rates, borrowing become more expensive reducing spending on imports. While this can make the UK exports more competitive, it can also attract foreign investment, strengthening the pound and potentially making exports more expensive
- Fiscal - This is about government management of taxes and spending. Increasing taxes or reducing government spending leaves people with less money, potentially reducing import purchases. While this doesn’t directly affect exchange rates, it can slow economic growth and job creation, making it a challenging decision for government.
- Supply-side policies - Improving the economy’s competitiveness through measures like privatisation or deregulation can boost exports over time. These polices aim to increase efficiency and reduce production costs.
- Wage reduction - Lowering wages, particularly in the public sector, can reduce production costs and improve export competitiveness. However, this approach may lead to lower aggregate demand.
- Protectionism - Implementing tariffs or quotas on imports can directly reduce the volume of imports.
What methods have the UK implemented?
The UK has implemented several methods to reduce its current account deficit:
- Fiscal targets - Set fiscal rules to manage public finances, including targets for government borrowing and debt
- The current rules aim to have public sector net debt falling as a % of GDP by the fifth year of the forecast period
- Additionally, keep public sector new borrowing below 3% of GDP in the same timeframe
- Monetary policy - The Bank of England has used interest rate adjustments to influence spending and investment.
- Welfare cap - The government has implemented a cap on certain welfare spending to control expenditure
While the fiscal targets are currently being met according to the Office for Budget Responsibility (OBR), the margin for success is narrow.
As we have seen, the current account deficit has persisted since the mid-1980s, suggesting that these policies have not fully addressed the underlying issues.