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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

A government wants to reduce a persistent current account deficit and, at the same time, keep domestic unemployment from rising. Which policy instrument is most directly aimed at improving the deficit by switching demand from imports to domestic output?

Allowing or engineering a currency depreciation is the expenditure-switching tool. It makes imports dearer and exports cheaper, moving demand toward domestic output and narrowing the current account deficit, without the deflationary effect on employment that tax rises or spending cuts would bring.

  1. ARaising the central bank policy rate sharply to attract capital inflows
  2. BDepreciating the currency, through exchange rate policy, so that imports become dearer and exports cheaperCorrect
  3. CIncreasing income tax rates to cut consumer spending overall
  4. DCutting government spending on infrastructure projects
  5. Raising the cash reserve ratio for banks

Explanation

Expenditure-switching policies such as depreciation change relative prices so that demand moves from foreign to domestic goods, improving the trade balance without necessarily reducing total demand. Higher tax rates or spending cuts are expenditure-reducing and tend to raise unemployment. Raising interest rates mainly affects the capital account and also depresses demand.

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