Implications of a Persistent Current Account Deficit/Surplus (HL)

Implications of a Persistent Current Account Deficit (AO3)

A persistent current account deficit may result in various consequences. This includes:

• Exchange rates: As explained here, a current account deficit means the currency is more supplied, causing depreciation. This can in turn increase overseas demand, causing an account surplus.

• Interest rates: More imports than exports -> Government may try to encourage investment by raising interest rates (so foreigners deposit more) -> Aggregate demand may contract

• Foreign ownership of domestic assets: As mentioned, a persistent deficit may cause the currency to depreciate. This makes domestic assets look cheaper to foreigners, hence more domestic assets may be bought by foreign companies

• Debt: With a persistent current account deficit, the government has to finance it, and has to take out loans

• Credit ratings: A persistent current account deficit may indicate economic troubles for a country, meaning credit rating agencies downgrade them. This means interest rates on loans the government takes out will be higher.

• Demand management: Current account deficits may occur in times of rapid growth in demand, and the government may try to impose contractionary demand-side policy (fiscal and monetary) to stop this

• Economic growth: All of the consequences mentioned above have negative effects on economic growth, as either consumption (C) or investment (I) is affected.

Implications of a Persistent Current Account Surplus (AO3)

However, this does not mean a persistent current account surplus is much better. Even though it means it can offset a financial account deficit, consequences include:

• Inflation & Domestic consumption and investment: Although a current account surplus means firms export more, hence economic growth occurs, this can lead to inflationary pressures which causes domestic C and I to contract.

• Exchange rates: As explained here, a current account surplus means the currency is more demanded, causing appreciation. This can in turn reduce overseas demand, causing an account deficit.

• Employment: More overseas demand means more jobs are demanded domestically to produce everything, increasing employment levels domestically (but potentially increasing unemployment abroad)

• Export competitiveness: A persistent surplus can cause the currency to appreciate, making goods look more expensive abroad, reducing competitiveness.