Readers Question: I’m currently reading ‘Crisis Economics’ (by N.Roubini) at the moment and I don’t get some stuff in the book. When it was talking about the current account balance, the book referred to it as a balance between national savings and national investment, but I don’t quite understand this.
The Current account on the Balance of payments measures the balance of trade in goods and services.
A deficit implies we import more goods and services than we export.
To be more precise, the current account equals:
- Trade in goods (visible balance)
- Trade in services (Invisible Balance) e.g. insurance and services
- Investment incomes e.g. dividends, interest and migrants remittances from abroad
- Net transfers – e.g. International aid
The current account is essentially exports – imports (+net international investment balance)
It is also worth noting that if we have a current account deficit, in a floating exchange rate this must be balanced by a surplus on the financial/capital account.
Why do economists say that the current account also equals saving – investment?
Firstly, it is worth remembering that in a closed economy, we assume that saving = investment. (S=I). For a firm to invest, it needs savings to be able to finance the investment. See: Saving and investment
Economists have noted that if domestic saving are lower than domestic investment, we will see a current account deficit. Why?
Before we look at a more mathematical approach, it is helpful to think of a country which experienced a rapid fall in savings, but investment levels stay the same. A fall in savings means people are spending more (higher consumption) therefore, this would tend to suck in imports as we buy goods and services from abroad.
But, also, if domestic savings fall – how will the domestic investment be financed? The investment must be financed by capital inflows from abroad.
A country like Japan has had a glut of saving over investment. This saving has tended to go abroad looking for more profitable investment. Therefore, Japan has had a deficit on capital flows, and a corresponding surplus on the current account.
The US, by contrast, has often had a level of investment greater than savings. This has been financed by capital inflows and a current account deficit.
