Question

Explain why, to reduce its current-account deficit, the US must either save more or invest less in its economy.

Answer 1

A current account deficit arises when the value of the imports (of revenue from goods / services / inv.) exceeds the value of the exports. Current account deficit reduction policies involve: exchange rate devaluation (making exports cheaper – imports more expensive) Reducing domestic demand and import spending (e.g. tight fiscal policy / higher taxes) Supply side policies to boost domestic production and exports competitiveness.

Economic policy must either reduce spending, increase private savings or reduce the budget deficit, in order to be successful in reducing the current account deficit. This policy merely acknowledges the fact that if the domestic uses of funds — spending and budget deficit — surpass the domestic source of funds — private savings — the surplus must be borrowed from abroad, resulting in a net inflow of money.
Apparently, cutting spending to reduce the current account deficit is not in the long-term interest of the economy. Hence, the best strategy for reducing the U.S. current account deficit is for economic policy to increase domestic savings and reduce the budget deficit.