The current account
Definition
Balance of payments: a record of all of a country's transactions with the rest of the world.
Current account: the part of the balance of payments used as a performance indicator, covering trade and income flows.
- The current account has four components: trade in goods, trade in services, primary income and secondary income.
Note
- Primary income covers earnings on investment, such as interest, profits and dividends flowing across borders.
- Secondary income covers transfers with nothing given in return, such as foreign aid and remittances.
The balance of trade
Definition
Balance of trade: exports minus imports of goods and services.
- A country can run a deficit in goods trade while running a surplus in services, as the UK often does.
Example
- Goods trade is −£40bn and services trade is +£25bn.
- Primary income is +£5bn and secondary income is −£10bn.
- So the current account deficit is £20bn, about 1% of a £2,000bn economy.
Deficits and surpluses
Definition
Current account deficit: more flows out than in on the current account items.
Current account surplus: more flows in than out on those items.
Financial account: the part of the balance of payments recording flows of investment and borrowing that finance a current account imbalance.
- Both the sign and the size relative to GDP matter when judging an imbalance.
- A deficit is financed through the financial account, for example by inflows of investment or borrowing from abroad.
Imbalances and objectives
- Current account imbalances are linked to other macroeconomic objectives such as growth, inflation and employment.
- A deficit may reflect strong domestic demand sucking in imports, while a large surplus may signal that demand at home is too weak.
- The seriousness of an imbalance depends on its size, its cause and how it is financed.
Note
- The UK has run a persistent current account deficit, often around 3-4% of GDP, cushioned by a surplus in trade in services such as finance.
- That deficit is financed by net inflows on the financial account, including foreign investment.
Global interconnectedness
Definition
Interconnectedness: the way trade and financial links tie economies together, so events in one spill over to its partners.
- International trade links economies, so one country's imports are another country's exports.
- One country's current account deficit is matched by surpluses elsewhere, so the balances across the world sum to zero.
- This interconnectedness means a slowdown or policy change in one economy spreads to its trading partners.
Is a current account deficit a problem?
- It holds because a large, persistent deficit means a country consumes more than it produces and relies on financing from abroad, which can threaten the currency if inflows dry up.
- But a deficit can be benign when it funds productive investment or reflects strong growth pulling in imports, and it is easily financed while foreign capital is willing to flow in, as in the UK.
- But the sign alone is not decisive: a large surplus can equally signal weak domestic demand, and since global balances sum to zero, not every country can run a surplus.
- On balance, whether a deficit is a problem depends on its size relative to GDP, its cause, and whether the financing is stable and sustainable.
Exam technique
- Distinguish the balance of trade from the whole current account, and the current account from the whole balance of payments.
- Judge a deficit or surplus by its size relative to GDP, its cause and how it is financed.
Common Mistake
- Do not treat the whole balance of payments as the current account, and do not leave out primary and secondary income.
- Do not assume a deficit is always bad or that only deficits matter, since large surpluses can also signal an imbalance.
Self review
- Name the four components of the current account.
- What is the balance of trade?
- How is a current account deficit financed?
- How are current account imbalances linked to other macroeconomic objectives?
- Why is one country's deficit another country's surplus?
