3.3 B Current
Account Problems
and Solutions
Pages 300-305
Learning Objectives
1.
2.
3.
Discuss the implications of a persistent current
account deficit and current account surplus
Explain and evaluate methods to correct a
persistent current account deficit including
expenditure switching policies, expenditure
reducing policies and supply-side policies, to
increase competitiveness.
Explain both the Marshall-Lerner condition and
the J-curve effect.
Causes of a Persistent Current Account deficit
Other countries switching
away from one’s exports
(due to poor quality or
high price)
 Other countries imported
consumer goods are
better quality or lower
price
Basically, a country is not
paying for what it buys
from overseas.

The other two accounts must be in surplus to allow
this to happen. What are the implications?
Thus there can be three dire consequences:
1. Foreign ownership of domestic assets increasing
1.
2.
“servicing” the interest on loans will grow, slowing
GDP

3.
Exacerbating the deficit due to more income payments
Interest rates will increase due to poorer credit rating
The exchange rate will come under downward
pressure.

Loan repayment becomes more expensive
The implications of a
Current account surplus


Appreciation leading to reduced export
competitiveness.
This means a country has a deficit on its capital
account (by building up foreign reserves, loans out
or purchasing assets), therefore…
 These
assets may lose value if the foreign currency
depreciates.
 Also, other countries can apply protectionism to
reduce their own current account deficits.
How to correct a Current Account deficit
A.
Expenditure-reducing policies – which
aim to reduce real income, thus reducing
the demand for all goods and services,
including imports
B.
Expenditure-switching policies – which
aim to increase spending on domestic
products instead of imports
A. Expenditure-reducing policies
1.
Contractionary monetary/fiscal policy.
This will reduce aggregate demand,
therefore reduce national income and
hence reduce demand for imports.
 Also,
if the Price Level falls, exports will
become more competitive.

What are the negative effects?
 Very
unpopular!
 Effects depends upon the “tool” used.) E.g.
B. Expenditure-switching policies
1.
Protectionism - raise the price - or reduce the
availability - of foreign goods (compared to
domestic goods)
 Cons:
2.
loss of gains from trade, retaliation.)
Supply-side policies – shift AS curve to the
right, the Price Level should fall, making
domestic products cheaper in greater quantity.
 Cons:
negative effect on distribution of income and
environment, etc.
Expenditure-switching policies continued…
3. Reducing the value of the currency – by
devaluation / depreciation
 See
3.2 B for how to do and its consequences
 This may not work immediately (The J-curve
effect might be seen - HL)
 Eventually this should work if the MarshallLerner condition holds (HL) – that is, if
demand for exports and imports are both
price elastic.
The M-L Condition
and The J Curve
The Marshall-Lerner condition
Based upon 1.2 theory: revenue changes when
price changes – depends upon PED
 M-L states that a fall in the exchange rate will
improve the Current Account if
PEd (exports) + PEd (imports) >1
 And that a rise in the exchange rate will worsen
the Current Account if
PEd (exports) + PEd (imports) <1
The J Curve Effect




In the short run, PED tends to be more inelastic
as importers and exporters take time to adjust
their spending habits (or firms stuck in contracts
take time to complete.)
This may lead to the J-curve effect, where a
depreciation at first worsens the B of P (as PED
of X and PED of M are inelastic)
Sooner or later importers and exporters adjust
their quantities more responsively to price, thus
an improvement in (X – M) will improve the CA.
Shown on a graph over time – it looks like
Effects of appreciation



At first, the CA might improve while PED of
export and imports are price inelastic; later the
PED of imports/exports rises and this will then
worsen the CA.
Thus, if the Marshall-Lerner condition holds –
then we should observe the opposite of the JCurve effect.
What shape would this look like?
Tasks
Discuss the implications of a persistent current
account deficit and current account surplus
 Explain and evaluate methods to correct a
persistent current account deficit including
expenditure switching policies, expenditure
reducing policies and supply-side policies.
 Explain both the Marshall-Lerner condition and
the J-curve effect.
Consolidate your knowledge:
 Student workpoint 24.3
 Student workpoint 24.4
