The current account of the balance of payments is the sum of the
balance of trade (exports minus imports of goods and services), net factor incomes (such as interest and dividends) and net transfer payments (such as foreign aid). A current account surplus increases a country's net foreign
assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are
included in the calculation. The balance of trade is typically the most important part
of the current account. This means that changes in the patterns of trade are key drivers in the current accounts of most of the
world's economies. However, for the few countries with substantial overseas assets or liabilities, net factor payments may be
significant. Together with Net Capital Outflow, they are a major metric of how much
a nation invests or is invested in.
The current account and the capital and financial account and change in official reserves each sum up to an offsetting
equality (are opposite in sign but same in magnitude) after errors and omissions are taken into account. This is a result of a
floating exchange rate system, where demand for a currency is equal to supply for a currency. This result can be proven with
simple algebra:
Demand for a Currency = Supply for a Currency
Exports + Income and Current Transfer Credits + Capital Inflow = Imports + Income and Current Transfer Debits + Capital
Outflow
ie. EX + IT Credits + Ki = IM + IT Debits + Ko
(EX - IM) + (IT Credits - IT Debits) = Ko - Ki
Alternatively,
A deficit on the current account = A surplus in the capital account
Or in the other case,
A surplus on the current account = A deficit on the capital account
This sum is known as the balance of payments. Typically, the changes in official
reserves is very small.
Action to reduce a substantial current account deficit usually involves increasing exports or decreasing imports. This may be
accomplished directly through import restrictions, quotas, or duties (though these may indirectly limit exports as well), or
subsidizing exports. Influencing the exchange rate to make exports cheaper for foreign buyers will indirectly affect the balance
of payments. This can be accomplished by increasing domestic inflation (e.g. by cutting interest rates), loosening monetary
policy (making more money available), or adjusting government spending to favor domestic suppliers.
Less obvious but more effective methods to reduce a current account deficit include measures that increase domestic savings
(or reduced domestic borrowing), including a reduction in borrowing by the national government.
It should be noted that a current account deficit is not always a problem. The "Pitchford Thesis" states that a current
account deficit does not matter if it is driven by the private sector. Some feel that this theory has held true for the
Australian economy, which has had a persistent current account deficit, yet has
experienced economic growth for the past 16 years (1991-2007). Others argue that Australia is accumulating a substantial foreign
debt that could become problematic, especially if interest rates increase. A deficit in the current account also implies that the
country is a net capital importer in relation to the rest of the world.
Interrelationships in the balance of payments
Absent changes in official reserves, the current account is the mirror image of the sum of the capital and financial accounts.
One might then ask: Is the current account driven by the capital and financial accounts or is it vice versa? The traditional
response is that the current account is the main causal factor, with capital and financial accounts simply reflecting financing
of a deficit or investment of funds arising as a result of a surplus. However, more recently some observers have suggested that
the opposite causal relationship may be important in some cases. In particular, it has controversially been suggested that the
United States current account deficit is driven by the desire of international investors
to acquire U.S. assets (See Ben Bernanke, William
Poole links below). However, the main viewpoint undoubtedly remains that the causative factor is the current account and
that the positive financial account reflects the need to finance the country's current account deficit.
See also
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