ABSTRACT
It was common practice for orthodox economic management to require that macroeconomic measures should be taken to reduce ‘excessive’ current account deficits.1 This was viewed as an additional task to that of achieving low unemployment without inflation. The open economy macroeconomic policy problem was supposed to be that of bringing the economy to target levels of domestic excess demand and the current account balance. This approach to policy arose when exchange rates were pegged or heavily managed and capital inflow to finance current account deficits was regulated or for some other reason in short supply. Governments faced with falling foreign exchange reserves and pressure for currency depreciation would be tempted to try to control the current account, the capital account and often both. A country whose current account was in surplus usually faced no such pressures.2 Its currency would be judged to be ‘high’ and it could accumulate foreign exchange reserves or lend abroad without fear of disapproval. Deficit countries, on the other hand, would feel it necessary to impose tariffs and quotas on imports, to subsidise exports and to use macroeconomic policy in an attempt to control the current account. Frequently, they also regulated financial capital flows. The notion that macroeconomic instruments should be employed to manage the current account deficit was supposed to be clearly spelt out by the internal/external balance approach, where the external balance target stood for the balance on current account. Many papers were written on how best to reach the twin targets, with various assignments of instruments to targets being argued for by different authors.
