Econ essay answers for week 6 (b)

Qn: Discuss which measures, if any, a government should adopt when confronted with a current account deficit. [15]

Interpretation of qn:
Discuss - Give details and explain pros and cons
Measures - Policies
If any - depend on size, cause, duration and exchange rate system

Comment from Cambridge:
- Need to distinguish between expenditure switching and expenditure reducing/dampening policy
- Need to give clear supporting analysis of each measure and evaluation of relative potential success of each measure bearing in mind the original cause of current account deficit

Ans:
Need not worry if current account deficit is not severe.
Severity depend on size, causes, duration and type of exchange rate regime

If small and temporary deficit, it can be financed by ...(copy from lecture note)
No need for government to intervene if freely floating exchange rate system.

In flexible exchange rate system, automatic correction ... (explain how automatic correction work)

When confronted with presistent and large current account deficit, government intervention is only necessary if operating on managed floating/fixed exchange rate system.

Measures can have 2 effects:
- Expenditure switching ( include definition)
- Expenditure reducing ( include definition)

Measures:
(I) Deflationary policies
- Explain
- Both expenditure switching and reducing
- Evaluate
(II) Import control
- Explain
- Expenditure switching
- Mention when use tariff or embargo based on price elasticity
- Evaluation
(III) Depreciation/Devaluation
- Explain
- Evaluation
(IV) Increase home productivity
- Explain
- Evaluation

Current account deficit would require not one but a combination of policies, taking into account their relative effectiveness.