Current Account

Definition

The current account is a record of a country's transactions with the rest of the world, including the balance of trade (exports minus imports of goods and services), net income from abroad, and net current transfers. It is a key measure of a country's economic performance and its relationship with the global economy.

5 Must Know Facts For Your Next Test

1. A current account surplus indicates that a country is a net lender to the rest of the world, while a current account deficit means the country is a net borrower.
2. The current account balance is influenced by a country's competitiveness, the strength of its currency, and the level of domestic and foreign demand for its goods and services.
3. Persistent current account deficits can lead to a buildup of foreign debt, which can make a country vulnerable to economic shocks and currency crises.
4. The current account is closely monitored by policymakers, as it can have significant implications for a country's exchange rate, inflation, and overall economic stability.
5. Concerns about large and persistent trade deficits have led to increased protectionist policies in some countries, as they aim to reduce imports and improve the current account balance.

Review Questions

• Explain how the current account balance relates to a country's trade balances and flows of financial capital.
  • The current account balance is directly influenced by a country's trade balance, which measures the difference between exports and imports of goods and services. A trade surplus, where exports exceed imports, contributes positively to the current account. Conversely, a trade deficit, where imports exceed exports, results in a current account deficit. The current account also includes net income from abroad, such as investment income and remittances, as well as net current transfers. These flows of financial capital between a country and the rest of the world are reflected in the current account balance.
• Discuss the pros and cons of trade deficits and surpluses in the context of the current account.
  • Trade deficits, which contribute to current account deficits, can have both positive and negative implications. On the positive side, they may allow a country to consume more than it produces, potentially boosting economic growth. However, persistent trade deficits can lead to a buildup of foreign debt, making the country vulnerable to economic shocks. Trade surpluses, on the other hand, contribute to current account surpluses, allowing a country to be a net lender to the rest of the world. This can provide financial stability, but it may also indicate a lack of domestic demand and investment. Policymakers must carefully balance the trade-offs between trade deficits and surpluses to maintain a healthy current account and overall economic performance.
• Analyze how the current account balance is influenced by the dynamics of the foreign exchange market.
  • The current account balance and the foreign exchange market are closely linked. The value of a country's currency relative to other currencies can significantly impact its current account position. A strong domestic currency makes imports cheaper and exports more expensive, leading to a current account deficit as imports rise and exports fall. Conversely, a weaker domestic currency makes exports more competitive and imports more expensive, potentially improving the current account balance. The foreign exchange market, where currencies are traded, determines the relative values of different currencies and, in turn, influences the current account balance. Policymakers may intervene in the foreign exchange market to manage the current account, either by allowing the currency to adjust or by implementing measures to directly influence the current account.

Related terms

Balance of Trade: The difference between a country's exports and imports of goods and services, representing the net trade position.

Capital Account: The account that records the net change in ownership of national assets, such as foreign direct investment and portfolio investment.

Foreign Exchange Market: The global decentralized market where currencies are traded, and which determines the relative values of different currencies.