Current Account Deficit

Definition

A current account deficit occurs when a country's total value of imports of goods, services, and capital exceeds the country's total value of exports, making it a net borrower from the rest of the world. This imbalance between a nation's spending and its income from the rest of the world is a key macroeconomic indicator.

5 Must Know Facts For Your Next Test

1. A current account deficit indicates that a country is a net borrower from the rest of the world, as it is spending more than it is earning from exports.
2. The current account deficit is financed by the capital account surplus, as the country must attract foreign capital to fund the deficit.
3. A persistent current account deficit can lead to a buildup of foreign debt, which can make a country more vulnerable to economic shocks and currency crises.
4. Factors that can contribute to a current account deficit include a high level of domestic consumption, an overvalued exchange rate, and a lack of competitiveness in the country's exports.
5. Policymakers may use fiscal and monetary policies to try to address a current account deficit, such as reducing government spending, increasing taxes, or implementing policies to boost exports and reduce imports.

Review Questions

• Explain how a current account deficit is measured and its relationship to the trade balance.
  • The current account deficit is measured as the difference between a country's total exports and total imports of goods, services, and capital. It represents the net flow of foreign currency into or out of the country. The current account deficit is closely related to the trade balance, which measures the net flow of goods and services. A current account deficit typically indicates a trade deficit, as the country is spending more on imports than it is earning from exports.
• Describe the potential consequences of a persistent current account deficit and how fiscal policy can be used to address it.
  • A persistent current account deficit can lead to a buildup of foreign debt, making a country more vulnerable to economic shocks and currency crises. Policymakers may use fiscal policy to address a current account deficit, such as reducing government spending or increasing taxes to lower domestic consumption and boost national savings. These measures can help to reduce the gap between a country's spending and its income from the rest of the world, thereby narrowing the current account deficit.
• Analyze the relationship between a country's fiscal policy and its current account balance, and explain how changes in government spending and taxation can affect the trade balance and the current account.
  • The relationship between a country's fiscal policy and its current account balance is complex, but generally, an expansionary fiscal policy (increased government spending or reduced taxes) can lead to a widening of the current account deficit. This is because the increase in domestic demand resulting from the fiscal stimulus will lead to higher imports, widening the trade deficit and contributing to a current account deficit. Conversely, a contractionary fiscal policy (reduced government spending or increased taxes) can help to narrow the current account deficit by reducing domestic demand and improving the trade balance. The specific impact will depend on factors such as the exchange rate, the country's competitiveness, and the response of private savings and investment to the fiscal policy changes.

Related terms

Trade Balance: The difference between a country's imports and exports of goods and services, representing the net inflow or outflow of foreign currency.

Capital Account: The account that records a country's net transactions in financial assets and liabilities, including foreign direct investment, portfolio investment, and loans.

Balance of Payments: The record of all economic transactions between a country and the rest of the world, including the current account and the capital account.