Current Account Deficit 💸

Introduction

• Current Account Deficit: When a country's total imports of goods, services, and transfers exceed its total exports.
• This lecture discusses the advanced consequences of a current account deficit, focusing on economic impacts.

Key Issues with Current Account Deficit

• Reduction in Aggregate Demand (AD)

  • The trade balance is a significant component of the current account.
  • A deficit implies a negative trade balance, meaning Net Exports (X - M) is negative.
  • Negative Net Exports reduce overall AD.
  • Reduced AD leads to lower economic growth and higher unemployment.

• Financing the Deficit with Debt

  • Countries often finance current account deficits by running financial account surpluses.
  • Common method: Issuing more debt (government bonds, corporate bonds, company shares).
  • Risk: Accumulating excessive debt erodes investor confidence.
  • Consequence: Investors may withdraw, fearing defaults, leading to insufficient funds to finance the deficit.

• Currency Crisis Risk

  • Fears of default lead to investors pulling out money, selling the country's currency.
  • Example: For the UK, this would mean selling the pound → lower pound value.
  • Depreciation of the currency exacerbates economic issues, potentially causing financial and economic crises.

Exchange Rate and Competitiveness

• Impact on Exchange Rate

  • Importing more than exporting increases the supply of the country’s currency on the global market.
  • Increased currency supply → downward pressure on the exchange rate.
  • Theoretically, a weaker currency should correct the deficit by making exports cheaper and imports more expensive.

• Challenges for Non-Competitive Economies

  • Countries suffering from deficits may lack competitiveness.
  • In the UK’s case, the weaker exchange rate might not boost exports due to a limited exporting base.
  • Negative Effects:
    • Higher import prices lead to increased costs for raw materials.
    • Potential stagflation: rising inflation combined with stagnating growth.

Conclusion

• If the current account deficit is small relative to GDP, financing it with debt might not be problematic.
• Critical Risk: When the deficit becomes a large percentage of GDP, debt concerns can cause severe economic consequences, including currency and economic crises.
• Monitoring and managing the current account deficit is essential to prevent these adverse outcomes.

Thanks for watching! See you next time.