Final answer:
To reduce a trade deficit, increasing tariffs or implementing stricter quotas on imported goods can be effective. Other methods may include promoting private saving or reducing the government budget deficit. However, policies such as increasing government spending are likely to exacerbate the trade deficit.
Step-by-step explanation:
An effective policy to reduce a trade deficit in a small open economy would likely involve increasing tariffs or stricter quotas on imported goods. By imposing trade barriers such as tariffs, a government can discourage imports, making foreign goods more expensive and less attractive compared to domestic products. This decrease in imports can help in reducing the trade deficit.
However, it is important to note that increasing government spending can worsen the trade deficit by stimulating domestic consumption, which may include imported goods. Increasing taxes could theoretically reduce a trade deficit by curbing spending and encouraging saving, but the effects are indirect and can be uncertain. Policies to increase private saving, or decreasing the government budget deficit, can also help, as they may decrease the need for foreign financial capital, which is one component leading towards a trade deficit.