Factors affecting Current Account Deficit | Economics Help
Current account balance (% of GDP) from The World Bank: Data. Monetary Fund, Balance of Payments Statistics Yearbook and data files, and World Bank and. These estimates are in constant prices (i.e. have been adjusted to account for The next chart plots the value of trade in goods relative to GDP (i.e. the value of of a causal relationship: trade is one of the factors driving economic growth. . a comparison of intercontinental trade, in per capita terms, for different countries. The terms of trade shows the relationship between export prices and import prices. When the terms of trade rise above they are said to be improving. This is shown in the chart below. . Earnings · Minimum and living wage; Trade; Current account · Trade with the EU · Exchange rates; Housing market; House prices.
Current Account Deficits: Is There a Problem? - Back to Basics: Finance & Development
Exchange Rate A depreciation in the exchange rate makes the currency relatively more competitive. After a depreciation, exports will be more competitive and imports more expensive.
This should improve the current account. However, it requires the demand for exports and imports to be relatively price elastic.
If demand is inelastic, then cheaper exports will only cause a small rise in demand and the actual value of exports can decrease. There is often a time lag effect between a depreciation in the exchange rate and improvement in the current account. In the short term, demand is inelastic, but over time, consumers become more price sensitive and the depreciation starts to improve the current account.
A depreciation may only cause a temporary improvement in the current account if it causes domestic inflation to increase. A depreciation can cause inflation for three reasons — 1 raises the price of imports, 2 increase domestic demand and also 3 may reduce the incentive of firms to cut costs — if this causes inflation, then the country will lose competitiveness and this will offset the improvement from the depreciation.
Balance of payments and Terms of Trade | Economics Help
Conversely, research also suggests that countries that are subject to large shocks should, on average, run current account surpluses as a form of precautionary saving.
When persistent is too persistent Does it matter how long a country runs a current account deficit? When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these need to be paid back. Common sense suggests that if a country fritters away its borrowed foreign funds on spending that yields no long-term productive gains, then its ability to repay—its basic solvency—might come into question.
This is because solvency requires that the country be willing and able to generate eventually sufficient current account surpluses to repay what it has borrowed to finance the current account deficits. Therefore, whether a country should run a current account deficit borrow more depends on the extent of its foreign liabilities its external debt and on whether the borrowing will finance investment with a higher marginal product than the interest rate or rate of return the country has to pay on its foreign liabilities.
But even if the country is intertemporally solvent—meaning that current liabilities will be covered by future revenues—its current account deficit may become unsustainable if it is unable to secure the necessary financing.
- Trade in goods and services
- Current account balance (% of GDP)
- Who does the UK trade with?
Such reversals can be highly disruptive because private consumption, investment, and government expenditure must be curtailed abruptly when foreign financing is no longer available and, indeed, a country is forced to run large surpluses to repay in short order what it borrowed in the past. This suggests that—regardless of why a country has a current account deficit and even if the deficit reflects desirable underlying trends —large and persistent deficits call for caution, lest a country experience an abrupt and painful reversal of financing.
What determines whether a country experiences such a reversal? Empirical research suggests that an overvalued real exchange rateinadequate foreign exchange reserves, excessively fast domestic credit growth, unfavorable terms of trade shocks, low growth in partner countries, and higher interest rates in industrial countries influence the occurrence of reversals. A deterioration in the balance of trade means a country is importing more than exporting.
Therefore more currency will be leaving a country. This would mean an increase in the supply of pound sterling and lower demand. Therefore, it is likely to cause a devaluation.
Balance of payments and Terms of Trade
This would mean cheaper exports and more expensive imports. We say this would be a deterioration in the terms of trade. Example, in the early s, the US has a large trade deficit, and this has been contributing to a devaluation of the dollar.