Question

Is a current account deficit something to worry about?

b. If a government wants to correct a current account deficit, why can’t it simply enforce restrictions on imports?

c. Why don’t exchange rates always adjust to correct current account deficits? In some cases, the home currency will remain strong even though a current account deficit exists, since other factors (such as international capital flows) can offset the forces placed on the currency by the current account.

Answer 1

Current account consists of all transactions relating to trade in goods and services and transfer payment . Goods or commodities traded are called visibles. Services are invisibles like travel, transportation, banking, insurance etc. Transfer payments are unilateral payments made to foreigners and received from foreigners.

Receipts from current account transactions are called current receipts. Expenditure on current account transactions are called current expenditure. If a country's current receipts are more than current expenditure, it is called current account surplus. If a country's current expenditure is more than current receipts it is called current account deficit. If current account receipts and current account expenditure are equal it is called current account balanced. Current account deficit has to be bridged through surplus in the capital account.

In the current account,merchandise exports and imports is the most important item. The difference between exports and imports of a country is its balance of trade.If visible exports exceed imports the balance of trade is favorable. In the opposite case it is unfavorable. It is however services and transfer payments or invisible items of the current account that reflect the true picture of the balance of payments accounts. They along with the visible items determine the actual current account position. If exports of goods and services exceeds imports of goods and services , the balance of payment is said to be favorable. In the opposite case it is unfavorable.

In the current account the exports of goods and services and the receipts of transfer payments are entered as credits because they represents receipts from foreigners. On the other hand the imports of goods and services and grant of transfer payments to foreigners are entered as debits because they represent payments to foreigners.

The balance of trade is the difference between the value of goods and services exported and imported. It contains the first two items of balance of payments accounts on the credit and debit side. This is known as balance of payments on current account.Some writers define the balance of trade as the difference between the value of merchandise imports and exports. Meade regards this way of defining the balance of trade as wrong and of minor economic significance from the point of view of the national income of the country. In equation form, the balance of payments is Y= C+I+G+(X-M) which includes all transactions which give a rise to or exhaust national income. In the equation, Y refers to national income , C to consumption expenditure , I to investment expenditure, G to government expenditure, X to exports of goods and services and M to imports of goods and services.The expression ( X-M) denotes the balance of trade. I f the difference between X and M is zero, the balance of trade balances. If X is greater than M , the balance of trade is favorable, or there is surplus balance of trade. On the other hand, if X is less than M, the balance of trade is in deficit or is unfavorable.

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