Is a Current Account Deficit a bad Thing?

 

Why a Current account is considered harmful to the economy

1. A current account deficit is financed through borrowing or foreign investment
2. Borrowing is unsustainable in the long term and countries will be burdened with high interest payments. E.g Russia was unable to pay its foreign debt back in 1998. Other developing countries have experience similar repayment problems Brazil, African c (3rd World debt)

 

3. Foreigners have an increasing claim on UK assets, which they could desire to be returned at any time. E.g. a severe financial crisis in Japan may cause them to repatriate their investments

4. Export sector may be better at creating jobs

 

5. A Balance of Payments deficit may cause a loss of confidence

 

 

However a current account deficit is not necessarily harmful

1. Current Account deficit could be used to finance investment

E.g. US ran a Current account deficit for a long time as it borrowed to invest in its economy. This enabled higher growth and so it was able to pay its debts back and countries had  confidence in lending the US money

2. Japanese investment has been good for UK economy not only did the economy benefit from increased investment but the Japanese firms also helped bring new working practices in which increased labour productivity.

 

3. With a floating exchange rate a large current account deficit should cause a devaluation which will help reduce the level of the deficit

It depend on the size of the budget deficit as a % of GDP, for example the US trade deficit has nearly reached 5% of GDP (02/03) at this level it is concerning economists

 

 

 

 

Revision Notes - Balance of Payments

Balance of Payments

Causes of Deficit

Policies to reduce deficit

Balance of Payments problem or not?

International Trade