Balance of Payments in Recession

Readers Question: But what happens to the balance of payments in a recession? (from: What happens in a recession)

In a recession, the current account is likely to show an improvement (reduction in deficit). This is because:

• In a recession consumer spending falls, therefore spending on imports decreases.
• In a recession, interest rates are cut, therefore exchange rate depreciates making exports cheaper and imports more expensive. This reduction in the exchange rate improves the current account.

Current account deficits are often cyclical – increasing when consumer demand is strong, reducing when consumer spending falls. This is certainly the case for a country like the UK, which has a high marginal propensity to import.

However, a recession is not guaranteed to improve the current account deficit, especially for countries like Germany and China who rely on export led growth. In a global recession they see a fall in the demand for their exports so could see a deterioration in the current account.

Also there is often a time lag before an exchange rate depreciation has an impact on the current account deficit.