Explain two government policies which could reduce a deficit on the current account of the balance of payments.

One policy the government could use is to put a tariff on imports. Tariff Diagram As the diagram shows, a tariff on imports would shift the world supply curve up to W+T and increase the price of imports. This will reduce demand for foreign goods from qw to qw2 and increase demand for domestic goods from qd to qd2. and therefore amount of imports will reduce. However, one problem with a tariff is that it will create deadweight loss as shown by the shaded region and it is is not efficient. Furthermore, although domestic producers will benefit, it will reduce choice for consumers and reduce consumer surplus. Lastly, it may not reduce the deficit if other countries retaliate by putting a tariff on the country's exports which may reduce exports. Given that the balance of payment depends on net export (exports-imports) if both exports and imports decrease, then the deficit may not decrease. Another policy the government could use is deflationary policy. The governmetn could try to reduce inflation by using contractionary fiscal policies such as reducing government expenditure. This will reduce national income and so reduce income of people which will reduce aggregate demand and so lead to lower inflation. Lower inflation in the country relative to the rest of the world will mean cheaper domestic goods compared to foreign goods so demand for domestic goods will increase whilst demand for foreign goods will decrease, therefore reducing imports. At the same time, foreign demand of domestic goods may increase because of lower relative inflation in the country and so exports may increase. A decrease in imports and increase in exports may then reduce the CA deficit.