A current account deficit occurs when the value of imports (of goods, services and investment incomes) is greater than the value of exports.
There are various factors which could cause a current account deficit:
1. Fixed Exchange Rate
If the currency is overvalued, imports will be cheaper and therefore there will be a higher Q of imports. Exports will become uncompetitive and therefore there will be a fall in the quantity of exports.
2. Economic Growth
If there is an increase in national income, people will tend to have more disposable income to consume goods. If domestic producers can not meet the domestic demand, consumers will have to import goods from abroad. In the UK we have a high Marginal propensity to imports mpm because we do not have a comparative advantage in the production of manufactured goods. Therefore if there is fast economic growth there tends to be a significant increase in the quantity of imports.
3. Decline in Competitiveness.
In the UK there has been a decline in the exporting manufacturing sector, because it has struggled to compete with developing countries in the far east. This has led to a persistent deficit in the balance of trade.
- Higher inflation
This makes exports less competitive and imports more competitive. However this factor may be offset by a decline in the value of sterling.
- Recession in other countries.
If the UK’s main trading partners experience negative economic growth then they will buy less of our exports, worsening the current account.
- Borrowing money
If countries are borrowing money to invest e.g third world countries
Deterioration in the current account