How does a current account surplus affect demand?

Readers Question: How does a current account surplus change demand in an economy?

A current account surplus means that the value of exports is greater than the value of imports (of goods and services).

Net exports is a component of Aggregate demand.  (AD) = C+I+G+(X-M).

Therefore a current account surplus means that the net exports is contributing to higher domestic demand. For example, China has had a significant current account surplus over the past few years. This high demand for exports is contributing to the high level of Chinese economic growth.

If the UK has a current account deficit, this represents a net leakage from the economy. Aggregate demand will be lower than if we had a surplus.

Evaluation

It could be the situation that a current account surplus is the result of a recession and low consumer spending. In a recession, we would expect to see a fall in consumer spending; therefore, we will see lower spending on imports. This will cause a current account surplus. In this case, the low aggregate demand is causing a current account surplus.

A current account surplus is not necessarily a good thing. For example, some criticise Germany for pursuing policies, which lead to a very large current account surplus. They argue that this is leading to lower demand in other European countries. Some economists argue, Germany should seek to boost domestic demand; this will lead to higher import spending and benefit other European countries with a large current account deficit and weak domestic demand.

On the positive side, a current account surplus is an indicator that Germany are very competitive, and this will help them to create jobs and economic growth.

Current account surplus and exchange rate

Another factor to consider is the impact of a current account on the exchange rate. In 2006, China was running a large current account surplus. However, in the past few years, the Chinese currency has steadily appreciated. This increase in value has reduced their current account surplus, and limited the growth in Chinese exports and domestic demand.

If the UK moved from a deficit to a surplus, we might expect to see an appreciation in the Pound (this is due to greater demand for Pounds as people buy more UK exports). The appreciation in the currency will tend to reduce demand (assuming relatively elastic demand)

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