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What Causes a Current Account deficit

Richard Pettinger

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A current account deficit on the Balance of Payments means that the value of imports for goods and services is greater than the value of exports. The US currently has a very large current account deficit, roughly between 6-7% of GDP. This deficit threatens to cause a significant devaluation in the US dollar. This essay looks at the causes of a balance of payments deficit.

Fixed Exchange Rate

If the currency is overvalued, imports will be cheaper and therefore there will be a higher Q of imports. Exports will become uncompetitive and therefore there will be a fall in the Quantity of exports.

Economic Growth

If there is an increase in AD and National Income increases, people will have more disposable income to consume goods. If domestic producers can not meet the domestic AD, consumers will have to imports goods from abroad. In the UK we have a high Marginal propensity to imports mpm because we do not have a comparative advantage in the production of manufactured goods. Therefore if there is fast economic growth there tends to be a big increase in imports.

Decline in Competitiveness.

IN the UK there has been a decline in the exporting manufacturing sector, because it has struggled to compete with developing countries in the far east. This has led to a persistent deficit in the balance of trade.

Higher inflation

This makes exports less competitive and imports more competitive. However this factor may be offset by a decline in the value of sterling.

Recession in other countries.

If the UK’s main trading partners experience negative economic growth then they will buy less of our exports, worsening the current account.

Borrowing money

If countries are borrowing money to invest e. g third world countries

In the US the main reason for a current account deficit is the high marginal propensity to consume of American consumers. This has been encouraged by relatively low interest rates, cuts in income tax for the wealthy and rising house prices. The recent fall in US house prices and therefore consumer spending may result in a lower deficit.

More: Economics Essays

Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys writing essays on Economic and he edits a site - Economic Help. Richard updates a blog on the UK and World Economy


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