Current Account Deficit & Imbalances

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Current Account Deficit

Many developed countries, including the UK and US, have significant current account deficits. This isn't a cause for concern in of itself, but could indicate wider problems with the economy.

Causes of a deficit

The following could cause a deficit:
- Low productivity, meaning the final price of the goods are likely to be higher.
- Inflation being higher domestically than abroad, reducing the international competitiveness of domestic goods.
- A strong exchange rate, reducing the price of imports and increasing the price of exports.
- Non-price factors, such as poor quality of goods and services.
- Supply-side constraints, which could cause a lot of goods being imported from abroad.

Is a current account deficit a concern?

If a deficit is because of capital goods imports, then it is likely to be good for future productivity and future growth.
If a deficit is because of the purchase of current goods, it will be good for the short-term standard of living.
If it because of a lot of FDI in the past, profits are being repatriated today. This means the investments were profitable.
If the deficit is a high % of GDP and is getting worse, this may be worrying.
If nobody wants to buy a country's exports, then this may be concerning.

Effects of a deficit

A current account deficit needs to be financed by a financial account surplus - so it will become a problem if foreign investors stop wanting to purchase assets in that country.
If a country has a free floating currency, the currency will depreciate. This may partially offset the uncompetitiveness of exports.
This will also cause the price of imports to rise though, leading to higher prices for consumers and potentially cost-push inflation.

Current Account Imbalances

Current account imbalances result because of trade between different countries. Current account balances can work for or against different macroeconomic objectives.

Trade makes economies interconnected

If the USA is running a current account deficit. To fund this deficit, it has to have a capital account surplus. It does this by selling US government debt (called treasuries) to foreign governments and international private investors.
If international investors and international governments no longer wanted to buy US government debt, then the USA would have to balance its current account.
International trade allows current account surpluses and deficits to develop.

Current account and economic growth

A current account surplus can mean that an economy is exporting a lot of goods.
GDP = C+I+G+(X-M). If exports are larger than imports, GDP may be rising.
If imports rise, M rises and GDP falls. So a current account deficit may signal weak economic growth.

Current account and employment

If there is a current account deficit, then economic growth may be slowing and unemployment may be rising.
However, if a developed economy like the UK is importing lots of primary goods like food and raw materials, then its labour force may be working in more productive economic areas like intellectual property.
The current account deficit could reflect a change in the structure of an economy and its labour force.

Current account and inflation

A current account deficit may show that a nation is importing lots of goods and services. However, if labour and input costs are cheaper overseas, this may reduce inflationary pressure.
If the price of goods made in China is a lot lower than the price of goods made in the UK, then a current account deficit could reduce inflationary pressure.