Balance of Payments - Current Account Deficits | tutor2u Economics
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Balance of Payments - Current Account Deficits

  • Levels: AS, A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

The current account of the balance of payments comprises the balance of trade in goods and services plus net investment incomes from overseas assets and net transfers.

Current Account Deficits - Revision Video

The balance of payments (BOP) records all financial transactions made between consumers, businesses and the government in one country with other nations

  • Inflows of foreign currency are counted as a positive entry (e.g. exports sold overseas)
  • Outflows of foreign currency are counted as a negative entry (e.g. imported goods and services)
  • The current account of the balance of payments is the main measure of external trade performance

Structural and cyclical causes of a current account deficit

Structural

  • Under-investment
  • Relatively low productivity
  • Persistently high relative inflation
  • Inadequate R&D, innovation
  • Emergence of lower cost competition

Cyclical

  • Over-valued exchange rate
  • Boom in domestic demand
  • Recession in key export markets
  • Slump in global prices of exports
  • Increased demand for imported technology

What does a current account deficit mean? Does it matter?

The current account balance for the UK (which includes trade, investment and financial transfers) was 4.1% of GDP in 2017, down from 5.8% of GDP in 2016.

Running a deficit on the current account means that an economy is not paying its way in the global economy. A deficit means a country is drawing in money from elsewhere and, as a consequence, building up corresponding liabilities – i.e. an increase in external debt.

  • A deficit is a net outflow of AD from circular flow – this is a drag on real GDP growth
  • Loss of jobs in export sectors & industries affected by rising imports – negative multiplier effects e.g. consider steel, coal etc.
  • Fall in foreign exchange reserves - can be problematic for smaller developing nations who struggle to attract financial capital
  • Can lead to exchange rate weakness - reducing real living standards and increasing investor risk – higher yields on government debt
  • Can a deficit be financed by hot money and portfolio investments?

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