Current syllabus: 2026–2028, Version 2 Official syllabus points: 6.5.1–6.5.2

Current Cambridge requirements

This topic must cover:

1. the government policy objective of stability of the current account;
2. the effects of fiscal, monetary, supply-side and protectionist policies on the current account.

The current Cambridge syllabus controls the topic. The older Excel in Economics teaching document is a secondary source only. It contains useful policy chains, but it also follows a wider legacy structure that includes the whole balance of payments, exchange-rate policy, exchange controls, foreign borrowing, formal expenditure-switching versus expenditure-reducing classification, Marshall–Lerner and J-curve analysis. Those items are not compulsory AS Topic 6.5 content and are separated below.

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Exam Essentials

1. What does current-account stability mean?

The current account records trade in goods, trade in services, primary income and secondary income.

A government seeking stability of the current account is trying to avoid imbalances that are excessively large, persistent or vulnerable to sudden correction.

Stability does not necessarily mean that the current-account balance must equal zero every year.

A deficit may be less concerning when it is temporary or associated with productive investment that expands future capacity. A surplus may reflect strong competitiveness, but an unusually large and persistent surplus can also indicate weak domestic demand or dependence on foreign demand. The sign alone does not reveal whether the balance is sustainable or desirable.

A good judgement considers:

• the size of the imbalance relative to the economy;
• whether it is temporary or persistent;
• the cause of the imbalance;
• whether productive capacity and competitiveness are improving;
• the risks created for output, employment, inflation and external confidence;
• conditions in trading partners and the global economy.

Core exam principle

Diagnose the cause before choosing the policy.

The same current-account deficit can arise from very different causes. A policy that is suitable for excessive domestic demand may be unsuitable for poor export competitiveness.

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2. Recap: how policies change the current account

A simplified current-account balance is:

CAB = balance of trade in goods and services + primary income balance + secondary income balance

Most AS policy analysis focuses on the trade channel:

trade balance = export revenue − import expenditure

A policy can improve the current account when, other things equal, it:

• raises export revenue;
• reduces import expenditure;
• improves net primary or secondary income flows.

A policy can worsen the current account when it has the opposite effects.

Do not assume that a fall in the physical quantity of imports guarantees an improvement. Import expenditure also depends on import prices. Likewise, higher export volume does not always mean higher export revenue.

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Diagnosing the imbalance

3. Common causes of a current-account deficit

A deficit may arise from:

• rapid growth of domestic income and spending, increasing imports;
• weak productivity, high unit costs or poor quality, reducing competitiveness;
• capacity constraints that prevent domestic firms meeting demand;
• dependence on imported food, fuel, machinery or components;
• weak foreign demand for the country’s exports;
• an appreciated currency, which may make exports dearer and imports cheaper;
• adverse movements in export and import prices;
• negative primary-income or secondary-income balances.

These causes suggest different policy responses.

Demand-led deficit

If imports are high because domestic aggregate demand and income are growing rapidly, contractionary fiscal or monetary policy may reduce import demand.

Competitiveness-led deficit

If exports are weak because productivity is low or costs are high, supply-side policy is more closely targeted.

Structural import dependence

If the country lacks domestic substitutes for essential imports, demand reduction or tariffs may have a limited effect and may impose large domestic costs.

Temporary external shock

A temporary rise in the world price of an essential import may not justify a large permanent policy change.

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4. Common causes of a current-account surplus

A surplus may arise from:

• strong export competitiveness;
• weak domestic consumption and investment, limiting imports;
• high saving relative to domestic investment;
• strong foreign demand;
• temporary commodity-price gains;
• positive primary-income receipts from overseas assets.

Policies intended to reduce a deficit may enlarge a surplus. For example, protectionism or fiscal contraction can reduce imports further. Current-account stability therefore requires policy direction to match the actual imbalance.

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Fiscal policy and the current account

5. Contractionary fiscal policy

Contractionary fiscal policy involves higher taxation and/or lower government spending.

Main deficit-correction chain

higher taxes or lower government spending → lower disposable income and/or lower aggregate demand → lower national income → lower demand for imports → import expenditure falls → current account may improve

A fall in demand may also reduce domestic inflationary pressure. If domestic prices and costs rise more slowly than those of trading partners, export competitiveness may improve over time.

Government-spending composition matters

A cut in government purchases of imported machinery directly reduces imports. A cut in domestic infrastructure or education may reduce imports in the short run but damage productive capacity and competitiveness later.

Therefore, the size and composition of fiscal adjustment matter—not simply whether spending falls.

Limitations and costs

Contractionary fiscal policy may:

• reduce real output and employment;
• lower domestic investment;
• damage public services;
• have little effect when import demand is income inelastic;
• be ineffective if the deficit mainly reflects poor competitiveness rather than excessive demand;
• worsen long-run performance if productive capital spending is cut.

It does not “force” firms to export. Firms can export more only if they have capacity, quality, competitive costs and foreign demand.

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6. Expansionary fiscal policy

Expansionary fiscal policy involves lower taxation and/or higher government spending.

lower taxes or higher government spending → higher aggregate demand and income → higher import demand → current account may move towards deficit or an existing deficit may widen

This can be appropriate when a country has an excessive surplus caused partly by weak domestic demand.

However, the effect depends on the import content of additional spending. Infrastructure investment may initially increase imports of machinery but later raise productivity and exports.

Fiscal policy: balanced conclusion

Fiscal policy is most directly suited to a demand-driven imbalance. It is less well targeted at structural export weakness unless the spending or tax change itself improves productivity and capacity.

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Monetary policy and the current account

7. Contractionary monetary policy

Contractionary monetary policy may involve:

• higher policy interest rates;
• slower money-supply growth;
• tighter credit regulations.

Domestic-demand channel

higher interest rates or tighter credit → borrowing and spending fall → consumption and investment fall → aggregate demand and income fall → demand for imports falls → current account may improve

Exchange-rate channel

Higher domestic interest rates may attract financial inflows and increase demand for the currency.

currency appreciates → exports may become dearer and imports cheaper → net exports may fall → current account may worsen

The two channels can work in opposite directions. A complete answer should not claim that higher interest rates must improve the current account.

Additional limitations

• Monetary policy works with time lags.
• Heavily indebted households may respond strongly, while cash-rich households may respond weakly.
• Firms may cut investment, reducing future competitiveness.
• Expectations, risk and foreign interest rates affect the exchange-rate response.
• Essential imports may not fall much when income falls.

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8. Expansionary monetary policy

Lower interest rates, faster money-supply growth or easier credit can raise domestic spending and imports, potentially reducing a surplus or worsening a deficit.

However, lower interest rates may also create depreciation pressure:

depreciation → exports become more price competitive and imports become dearer → net exports may improve

Again, the domestic-demand and exchange-rate channels can oppose each other. The final current-account effect is conditional.

Monetary policy: balanced conclusion

Monetary policy may influence the current account, but it is primarily a broad macroeconomic tool. Its exchange-rate effects, domestic-demand effects and impact on investment must all be considered.

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Supply-side policy and the current account

9. How supply-side policy can improve a deficit

Supply-side policy aims to raise productivity and productive capacity. Relevant measures include:

• education and training;
• infrastructure development;
• support for technological improvement;
• measures that improve competition, business efficiency and labour mobility.

Competitiveness chain

better skills, technology or infrastructure → productivity rises → unit costs may fall and quality/reliability may improve → exports become more competitive → export revenue may rise → current account may improve

Import-substitution chain

domestic capacity and quality improve → consumers and firms can purchase more competitive domestic alternatives → import demand may fall → current account may improve

Advantages

Supply-side policy can address the underlying cause of a structural deficit without deliberately reducing national income. It may also support economic growth and employment.

Limitations

• Effects often take years.
• Government projects can be poorly targeted or inefficient.
• Improved productivity does not guarantee foreign demand.
• Higher income after successful reform may increase imports.
• New machinery and technology may need to be imported, worsening the current account initially.
• Benefits depend on exchange rates, global demand and firms’ ability to expand.

Supply-side policy: balanced conclusion

Supply-side measures are usually better suited to competitiveness-led deficits than to short-lived demand shocks. They are potentially durable but slow and uncertain.

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Protectionist policy and the current account

10. How protectionism can affect the current account

Protectionist measures include tariffs, import quotas, export subsidies, embargoes and excessive administrative burdens.

Import-reduction chain

tariff or quota raises the domestic price or limits the availability of imports → quantity of imports may fall → import expenditure may fall → current account may improve

The effect depends on the price elasticity of demand for imports and on whether higher prices offset the fall in quantity.

Export-support chain

An export subsidy may lower exporters’ effective costs or allow a lower foreign price, increasing exports. However, it imposes a fiscal cost and may provoke disputes or retaliation.

Limitations and risks

Protectionism may:

• provoke retaliation against exports;
• raise costs for firms using imported components;
• increase inflation and reduce real incomes;
• protect inefficient domestic producers;
• reduce competition, choice and innovation;
• divert imports rather than reduce total import expenditure;
• breach trade commitments or create political conflict;
• correct the visible trade balance without solving weak productivity.

Protectionism: balanced conclusion

Protectionism may reduce selected imports quickly, but its overall current-account effect can be offset by retaliation, higher input costs and weaker exports. It is rarely a complete long-run solution to structural weakness.

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Correcting a deficit: integrated analysis

11. Policy choice by cause

A deficit caused by several factors may require a policy mix.

12. Worked deficit example

Suppose a country has:

• exports of goods and services: $420 billion;
• imports of goods and services: $500 billion;
• net primary and secondary income: +$20 billion.

Initial CAB:

420 − 500 + 20 = −$60 billion

A supply-side programme raises exports by $25 billion, while a temporary fiscal contraction reduces imports by $20 billion.

New CAB:

445 − 480 + 20 = −$15 billion

The deficit narrows by $45 billion. The current account has not reached zero, but it may be more stable if the improvement is durable and the domestic costs are acceptable.

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Correcting a surplus

13. Why a government might reduce an excessive surplus

A very large persistent surplus can expose the economy to weak demand abroad, encourage trade tensions and coexist with weak domestic consumption or investment.

Possible adjustment includes:

• expansionary fiscal policy that raises domestic spending and imports;
• expansionary monetary policy that raises domestic demand;
• removing unnecessary import restrictions;
• policies that encourage productive domestic investment and consumption.

Surplus-policy chain

higher domestic demand → imports rise → surplus narrows

Supply-side policy designed purely to raise exports, or additional protectionism designed to cut imports, may enlarge the surplus rather than stabilise it.

Do not treat surplus reduction as automatically desirable

A surplus generated by temporary export strength or income receipts may not require aggressive intervention. The government should evaluate persistence, cause and wider objectives.

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Evaluation framework

14. Conditions determining policy effectiveness

14.1 Cause of the imbalance

A demand-management policy is better targeted at excessive spending than at low productivity.

14.2 Income elasticity of demand for imports

If import demand responds strongly to income, a fall in national income may reduce imports substantially. If imports are essentials, the response may be small.

14.3 Price elasticity and availability of substitutes

A tariff or competitiveness improvement is more effective when consumers can switch between imported and domestic products and when foreign buyers respond to export-price changes.

14.4 Spare capacity

Supply-side or export growth can raise real output more easily when firms have or can create capacity. Demand contraction imposes larger output and employment costs when the economy is already weak.

14.5 Import dependence

Policies that raise import prices can damage firms that depend on foreign energy, machinery and components.

14.6 Time lags

Fiscal and monetary policy may affect spending with a lag. Training, infrastructure and technological improvement often require much longer.

14.7 Retaliation and global conditions

Protectionism may reduce imports but also exports if trading partners retaliate. Weak global demand can limit export gains from any domestic policy.

14.8 Exchange-rate response

Tighter monetary policy may reduce imports through lower demand while appreciation weakens net exports. The net current-account effect is not predetermined.

14.9 Policy side effects

A policy may improve the current account while worsening unemployment, growth, inflation, inequality or public-service quality. The strongest answer weighs the external objective against domestic costs.

14.10 Composition and quality

A current-account improvement caused by recession is different from one caused by higher productivity and diversified exports. Both improve the numerical balance, but only one is likely to support sustainable growth.

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Policy comparison

15. Summary table

No policy is always best. The answer depends on the source, size and persistence of the imbalance and on the government’s other objectives.

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Exam Mastery

16. Building a strong policy chain

Use five links:

1. Instrument — identify the exact policy change.
2. Transmission — explain income, costs, competitiveness or relative-price effects.
3. Trade response — explain what happens to exports or imports.
4. Current-account result — state whether the balance improves or worsens.
5. Condition — identify what determines the size or direction of the effect.

Example:

The government raises income tax. Disposable income falls, reducing consumption and aggregate demand. National income falls, so households buy fewer imports. Import expenditure may fall and the current-account deficit may narrow. The effect will be smaller if imports are necessities with low income elasticity, and the policy may raise unemployment.

17. Comparing policies in an essay

A strong comparison should not simply list advantages and disadvantages. Compare policies using common criteria:

• speed;
• sustainability;
• precision;
• output and employment cost;
• inflation effect;
• retaliation risk;
• administrative and fiscal cost;
• suitability for the cause.

18. Data-response method

When given current-account figures:

1. identify whether there is a deficit or surplus;
2. calculate the initial balance if necessary;
3. identify which component changes;
4. apply the policy chain;
5. recalculate the balance;
6. distinguish a numerical improvement from a sustainable improvement.

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Common errors

19. Exam traps

Error 1: “Current-account stability means zero”

A stable position need not be exactly balanced every year.

Error 2: Treating every deficit as harmful

The cause, use of resources, size and persistence matter.

Error 3: Using the whole balance of payments

AS Topic 6.5 focuses on the current account, not detailed financial- and capital-account accounting.

Error 4: Assuming higher interest rates must improve the current account

Lower import demand can be offset by appreciation and weaker exports.

Error 5: Assuming lower government spending increases exports

It may reduce imports, but it does not automatically create export demand or capacity.

Error 6: Treating protectionism as costless

Retaliation, imported-input costs, inflation and efficiency losses may offset the benefit.

Error 7: Treating supply-side policy as immediate

Its major effects are often long term.

Error 8: Using devaluation, Marshall–Lerner or the J curve as compulsory AS analysis

Exchange-rate policy belongs to A Level Topic 11.1, while Marshall–Lerner and J-curve analysis belong to A Level Topic 11.2.

Error 9: Confusing a recession-led improvement with stronger competitiveness

Imports may fall because income collapses. The balance improves, but welfare and productive performance may worsen.

Error 10: Ignoring surpluses

The syllabus refers to imbalances, so policy effects should be understood for both deficits and surpluses.

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Current-syllabus boundary

20. What is not compulsory in AS Topic 6.5?

The following may be helpful background but must not be built into the compulsory mastery route:

• full current, financial and capital-account accounting;
• exchange-rate policy, devaluation and revaluation;
• formal assessment of exchange controls;
• foreign borrowing as a way to finance rather than correct a deficit;
• the formal distinction between expenditure-switching and expenditure-reducing policies;
• Marshall–Lerner condition;
• J-curve analysis;
• detailed policy-effectiveness analysis across every macroeconomic objective.

These are treated later in A Level Topics 10.3, 11.1 and 11.2.

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Final synthesis

21. The central logic

Current-account stability is not achieved by choosing one policy mechanically.

• Fiscal and monetary contraction can reduce import demand, but may lower output and employment.
• Monetary tightening can appreciate the currency and weaken the current account through trade prices.
• Supply-side policy can improve competitiveness and capacity, but takes time and may initially raise capital imports.
• Protectionism can reduce selected imports, but retaliation, inflation and higher input costs can reduce or reverse the gain.
• Excessive surpluses may require stronger domestic demand rather than further import restraint.

The best policy is the one that addresses the cause of the imbalance while producing acceptable domestic and external consequences.