Balance-of-payments accounts and adjustment policies
Balance-of-payments accounts and adjustment policies: build the core model, apply it to evidence and qualify conclusions where outcomes depend on context.
Section 11.1 · Policies to correct disequilibrium in the balance of payments
9708 section 11.1; A Level. Checked against Cambridge's 2026–2028 Version 2 (latest version published December 2025) and 2029 Version 1 (published September 2026). Cambridge states that neither version has significant changes affecting teaching. Always follow the syllabus for the candidate's examination year.
Before you begin
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which policy is primarily expenditure-reducing?
What you will learn
- Distinguish the current, capital and financial accounts
- Evaluate fiscal, monetary, supply-side, protectionist and exchange-rate policies
- Distinguish expenditure-switching from expenditure-reducing policies
Core model and terms
The current account records trade in goods and services and income and transfer flows; the capital account records specified capital transfers and non-produced assets; the financial account records cross-border investment and financial flows. Interpret the sign using the accounting convention stated in the data. A current-account deficit is not automatically a crisis: its cause, financing, persistence and use of funds matter.
Apply and evaluate
Fiscal or monetary restraint may reduce income and import demand, but can also lower output and employment. Supply-side policies may improve productivity and competitiveness over time. Protectionist measures and exchange-rate changes can redirect spending between domestic and foreign goods. Expenditure-reducing policies lower total domestic demand; expenditure-switching policies change relative prices or incentives to move spending toward domestic output. Every measure has timing, distribution, partner-response and retaliation risks.
Pause and explain
Which statement best applies balance-of-payments accounts and adjustment policies?
Worked example
A country has a persistent current-account deficit. Explain how an expenditure-reducing and an expenditure-switching policy could affect imports, and identify one cost to compare.
Show the worked solution
- Fiscal restraint can reduce household income and import demand
- Depreciation or a tariff can make imports relatively less attractive and switch demand toward domestic output
- Compare effects on output, prices, consumers, trade partners and export responses
Answer Fiscal restraint can reduce household income and import demand → Depreciation or a tariff can make imports relatively less attractive and switch demand toward domestic output → Compare effects on output, prices, consumers, trade partners and export responses
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Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A country has a persistent current-account deficit. Explain how an expenditure-reducing and an expenditure-switching policy could affect imports, and identify one cost to compare.
Give me a hint
Contrast lower total spending with a change in relative prices.
Compare my reasoning
- Fiscal restraint can reduce household income and import demand
- Depreciation or a tariff can make imports relatively less attractive and switch demand toward domestic output
- Compare effects on output, prices, consumers, trade partners and export responses
Fiscal restraint can reduce household income and import demand Depreciation or a tariff can make imports relatively less attractive and switch demand toward domestic output Compare effects on output, prices, consumers, trade partners and export responses
Look for these in your work
- Fiscal restraint can reduce household income and import demand
- Depreciation or a tariff can make imports relatively less attractive and switch demand toward domestic output
- Compare effects on output, prices, consumers, trade partners and export responses
A country records a $40bn current-account deficit and a financial-account surplus. Explain how the entries can coexist.
Give me a hint
Separate trade and income flows from cross-border financing flows.
Compare my reasoning
- The current account records net current transactions
- A financial-account surplus records net financing inflows under the stated sign convention
- Capital flows can finance a current-account deficit, but do not remove its underlying causes
The current account records net current transactions A financial-account surplus records net financing inflows under the stated sign convention Capital flows can finance a current-account deficit, but do not remove its underlying causes
Look for these in your work
- The current account records net current transactions
- A financial-account surplus records net financing inflows under the stated sign convention
- Capital flows can finance a current-account deficit, but do not remove its underlying causes
Why might an import tariff improve one domestic industry’s sales but fail to correct the overall balance of payments?
Give me a hint
Consider import substitution, retaliation and the economy-wide source of the imbalance.
Compare my reasoning
- The tariff can switch demand toward protected domestic output
- Imports of other goods or inputs may still rise
- Retaliation, higher costs and unchanged saving–investment conditions can limit the overall effect
The tariff can switch demand toward protected domestic output Imports of other goods or inputs may still rise Retaliation, higher costs and unchanged saving–investment conditions can limit the overall effect
Look for these in your work
- The tariff can switch demand toward protected domestic output
- Imports of other goods or inputs may still rise
- Retaliation, higher costs and unchanged saving–investment conditions can limit the overall effect
A country lowers interest rates during a deficit. Explain one possible current-account effect and one uncertainty.
Give me a hint
Trace domestic spending and then investment or exchange-rate channels.
Compare my reasoning
- Cheaper credit can raise demand and imports
- A lower rate may also weaken the currency and support exports
- The net effect depends on import content, capacity, capital flows and timing
Cheaper credit can raise demand and imports A lower rate may also weaken the currency and support exports The net effect depends on import content, capacity, capital flows and timing
Look for these in your work
- Cheaper credit can raise demand and imports
- A lower rate may also weaken the currency and support exports
- The net effect depends on import content, capacity, capital flows and timing
Common mistakes
- Assuming every current-account deficit is unsustainable or that one policy can correct it without affecting output, prices or other objectives.
What can you explain now?
Which policy is primarily expenditure-reducing?
Compare with the explanation
A fiscal contraction that lowers aggregate domestic spending
It aims to reduce total expenditure, which may also lower imports.
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Make it stick
Before moving on, explain the central idea in balance-of-payments accounts and adjustment policies and state one condition that could change its effect.
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