Current Account Deficit
In 1994 the UK had a Balance of Payments
current account deficit. Explain the
possible effects that this deficit might
have upon the economy Discuss what, if
anything the UK Government could have
done to reduce or eliminate this current
account deficit. The balance of
payments is a record of one country's trade
dealings with the rest of the
world. Any transaction involving UK and foreign
citizens is calculated in
sterling (UK pounds). Dealings, which result in money
entering the country,
are credit (plus) items while transactions, which lead to
money leaving the
country, are debit (minus) items. The balance of payments can
be split up
into two sections: 1. the current account which deal with
international trade
in goods and services; 2. transactions in assets and
liabilities which deals
with overseas flows of money from international
investments and loans; The
current account consists of international dealings in
goods (visible trade)
and services (invisible trade). Invisible trade includes
payments for
overseas embassies and military bases: interest, profit and
dividends from
overseas investment; earnings from tourism and transportation.
The cause
of a deficit was that the UK imported more visible goods than it
exported and
there was a net deficit on transfers, our service earnings plus
overseas
incomes did not exceed our service payments plus investment income
paid
abroad sufficiently to prevent the balance on current account being well
in
deficit. The state of the trade balance is extremely important since
changes in
imports and exports have a important bearing on the real economy
and in
particular on output and employment. In the longer run, a persistent
deficit, if
it cannot be offset by a surplus on invisibles, will have serious
implications.
It will handicap the conduct of the macroeconomic policy.
Its effect will be to
increase instability of exchange rates and/or interest
rates as the UK becomes
dependent on inflows of hot money to finance the
deficit. Higher interest rates
are also likely to cause a reduction in real
investment and therefore in
economic growth. The current account deficit
might also be financed by increased
sales of assets to overseas firms and
residents, which in the long run, will
lead to an increased outflow of
interest, profits and dividends. The balance of
payments always balances
because of official financing. However, a balance of
payments deficit means a
persistent and large negative balance for official
financing. This can be the
result of excessive purchases of foreign goods and
services or excessive UK
investment overseas. In the short term, a balance of
payments deficit can be
corrected by: ? continued borrowing of foreign
currency; ? increasing
interest rates to attract overseas investors;
? imposing exchange controls; ?
Imposing tariffs and import
quotas. In the long run, the government can
correct a balance of payments
deficit by reducing demand in the economy for
all goods including imports.
Reducing UK inflation rates or encouraging a
sterling depreciation will also
help. The correct measures to remedy a
deficit will depend upon its cause and
also upon the exchange rate regime. A
short-term deficit might be dealt with by
running down reserves or by
borrowing. Another short-term measure might be to
raise interest rates to
encourage the inflow money. When there is a more
fundamental payments
deficit, other methods will have to be taken. The following
show ways in
which the government can tackle the problem of a deficit in the
Current
Accounts. Deflation is where the demand for imports are restrained
by
restricting the total level of demand in the country through fiscal and
monetary
polices Protection is where the country cuts all trade with the
outside world by
cutting off all imports and therefore protecting the home
market from foreign
competition Devaluation is where a fixed exchange rate
drops the external price
of its currency, as the UK did in 1967 when the rate
changed from £1=$2.80 to
£1=£2.40, this is referred to as a devaluation which
means exports will now
appear cheaper to foreigners while imports will seem
more expensive to
domestic
customers.