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Stablisation Policies

Exam code: 2281
Written by: Ashika|Reviewed by: Caroline Carroll|Updated 2 July 2026

Policies that stabilise the current account balance

Policies that stabilise the current account balance

  • The government have several policies (fiscal, monetary and supply-side policy) available to them in order to address a Current Account deficit or to stabilise the current account balance

They could do nothing

  • Leaving it to market forces in the foreign exchange market to self-correct the deficit 

Advantage

Disadvantage

  • Floating exchange rates act as a self-correcting mechanism

  • Over time a higher level of imports will end up depreciating the currency, causing imports to decrease (they are now more expensive) and exports to increase (they are now cheaper)

  • This improves the deficit 

  • There may be other external factors that prevent the currency from depreciating

  • It may take a long time for self-correction to happen and many domestic industries may go out of business in the interim

  • The longer it takes to self-correct, the more firms will delay investment in the economy

Expenditure-switching policies

  • These policies aim to switch consumer expenditure from purchasing abroad to purchasing domestically

  • These include

    • Protectionist policies which raise the price of imports, so consumers switch to buying domestic goods

    • Currency depreciation, which makes the price of imports more expensive and so consumers switch to buying domestic products

Advantage

Disadvantage

  • These are often successful in changing the buying habits of consumers, switching consumption from imports to consumption of domestically produced goods and services

  • This helps improve a deficit

  • Any protectionist policy often leads to retaliation by trading partners.

  • This may consist of reverse tariffs or quotas which will decrease the level of exports

  • This may offset any improvement to the deficit caused by the policy

Expenditure-reducing policies

  • Measures designed to reduce total (aggregate) demand in an economy, such as contractionary fiscal or monetary policy

  • These include

    • Raising taxes which cause consumers to have lower disposable income and so they spend less on imports

    • Raising interest rates which reduces the level of borrowing resulting in a fall in the level of imports

Advantage

Disadvantage

  • Contractionary fiscal policy invariably reduces discretionary income, which leads to a fall in the demand for imported goods and improves a deficit

  • Contractionary fiscal policy also dampens domestic demand, which can cause output to fall

  • When output falls, GDP growth slows and unemployment may increase

Supply-side policies

  • These aim to improve the quantity and quality of the factors of production, thereby raising potential output

    • Investment in education which raises productivity making exports cheaper and more attractive

    • Investment in infrastructure which lowers costs for firms making exports cheaper and more attractive

Advantage

Disadvantage

  • Improves the quality of products and lowers the costs of production.

  • Both of these factors help the level of exports to increase, thus reducing the deficit

  • These policies tend to be long-term policies so the benefits may not be seen for some time

  • They usually involve government spending in the form of subsidies and this always carries an opportunity cost

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