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International Monetary Economics

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From the Keynesian identity it can be deduced that the current account deficit is caused by the reduction of the private spending and a large budget deficit. This model was applied to the international trade by Keynes.Keynes designed this model just to deal with the current account deficit that UK was suffering from in the 1960s. Since at that time the foreign capital investment was minimal and there was a fixed exchange rate system in the UK, most of the policies of the Keynesians work according to these two conditions.The Keynesian model relies greatly on the expenditure changing policies. The expenditure changing policies are designed to change the level of spending in the domestic economy. This can be explained through the income and the adjustment model.Since the expenditure that is spent on the imports results in a loss of the money and income to the foreign countries, it is considered an injection. The Keynesian model states that in order to maintain or improve the circular flow of income it is important that the expenditure on the imports is reduced. This can be done if the income in the country is reduced.The domestic income has a direct relation with the imports of a country. This is because as the income in the country increases, there is an increased amount spent on the imports. Also the increase in the income means that the production of the country has increased. The production process may also involve raw materials that are to be imported. As a result the expenditure on the imports would be further increased. In order to reduce the expenditure spent on the imports the Keynesian policies propose the reduction of the domestic production. Since the Keynesian identity is also applicable to the domestic economy (without the net imports), the governments can reduce the government expenditure and reduce the taxes etc to decrease the domestic activity and so the expenditure