📉 Causes of Current Account Deficits
- Strong domestic demand — when the economy grows fast, consumers buy more imports.
- Overvalued exchange rate — makes exports expensive and imports cheap.
- High relative inflation — domestic goods become less competitive.
- Low productivity/competitiveness — domestic firms can't compete with foreign producers.
- Dependence on primary commodity exports — volatile prices and low value-added.
- High income levels — wealthier consumers tend to import more (higher marginal propensity to import).
A deficit is not always 'bad'. It may reflect strong growth and investment (capital good imports) rather than structural weakness.
⚠️ Consequences of Persistent Imbalances
Persistent deficit
- Rising foreign debt — the country must borrow to finance the gap.
- Depreciation pressure — continuous selling of the domestic currency.
- Loss of confidence — investors may pull out, triggering a currency crisis.
- Reduced reserves — if the central bank defends the currency, reserves deplete.
Persistent surplus
- Appreciation pressure — currency strengthens, eventually hurting export competitiveness.
- Trading partner resentment — seen as 'unfair' if maintained through undervalued currency.
- Under-consumption — domestic consumers may be worse off if they're not enjoying the benefits of trade.
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🔧 Corrective Policies
Expenditure-reducing policies
- Contractionary fiscal policy — reduce government spending or raise taxes → lower AD → fewer imports. But: causes unemployment and slower growth.
- Contractionary monetary policy — raise interest rates → reduces consumer spending and investment → fewer imports. But: slows growth and raises debt costs.
Expenditure-switching policies
- Devaluation/depreciation — make the currency cheaper → exports more competitive, imports more expensive. But: J-curve delay, imported inflation.
- Trade protection — tariffs/quotas reduce imports. But: retaliation, misallocation, WTO violations.
- Supply-side policies — improve productivity and competitiveness (education, R&D, infrastructure). Long-term but most sustainable.
The best IB answers combine short-run measures (expenditure-reducing) with long-run structural reforms (supply-side) and evaluate the trade-offs of each.