UK Trade Deficit

The UK’s persistent trade deficit reduced in Dec 2008

The UK’s balance of trade in goods and services reported a deficit of £3.6 million in December. Compared to a deficit of £4.0 billion in November.

Why UK Trade Deficit has Improved

  • Depreciation in Sterling. A trade weighted index of sterling is 20% lower than in the summer of 2008. The fall in the value of the Pound makes exports cheaper and imports more expensive.
  • Exports have shown only a very modest increase because the recession in Europe has reduced export demand from Europe. Even though exports are cheaper weaker domestic demand means demand is not rising.
  • Imports are falling significantly because Imports are more expensive and the slowdown in UK consumer spending means we are buying less goods, especially luxury imported goods.

J Curve Effect

Students of Economics will know, that the effect of a depreciation on the trade deficit   depends on elasticity of demand. In the short term, demand is often inelastic. Therefore, cheaper exports fail to increase export revenue. However, in the long term demand becomes more elastic so the trade deficit improves over time.

The J Curve effect says a trade deficit can actually worsen after a depreciation, but get better in the long term.

j-curve-effect

In the future the trade deficit may continue to improve if global demand picks up.

By on February 12th, 2011