What Is a Current Account Deficit?
The current account deficit is a measurement of a country’s trade where
the value of the goods and services it imports exceeds the value of the products it exports. The current account includes net income, such as interest and dividends, and transfers, such as foreign aid, although these components make up only a small percentage of the total current account. The current account represents a country’s foreign transactions and, like the capital account, is a component of a country’s
balance of payments (BOP).
Current Account Deficit
Key Takeaways
- A current account deficit indicates that a country is importing more than it is exporting.
- Emerging economies often run surpluses, and developed countries tend to run deficits.
- A current account deficit is not always detrimental to a nation's economy—external debt may be used to finance lucrative investments.
Understanding a Current Account Deficit
A country can reduce its existing debt by increasing the value of its exports relative to the value of imports. It can place restrictions on imports, such as tariffs or quotas, or it can emphasize policies that promote export, such as import substitution, industrialization, or policies that improve domestic companies' global competitiveness. The country can also use monetary policy to improve the
domestic currency’s valuation relative to other currencies through devaluation, which reduces the country’s export costs.
While an existing deficit can imply that a country is spending beyond its means, having a current account deficit is not
inherently disadvantageous. If a country uses external debt to finance investments that have higher returns than the interest rate on the debt, the country can remain solvent while running a current account deficit. If a country is unlikely to cover current debt levels with future revenue streams, however, it may become insolvent.
Deficits in Developed and Emerging Economies
A current account deficit represents
negative net sales abroad. Developed countries, such as the United States, often run deficits while emerging economies often run current account surpluses. Impoverished countries tend to run current account debt.
Real World Example of Current Account Deficits
Fluctuations in a country's current account are largely dependent on market forces. Even countries that purposefully run deficits have volatility in
the deficit. The United Kingdom, for example, saw a decrease in its existing deficit after the Brexit vote results in 2016.
The United Kingdom has traditionally run a deficit because it is a country that uses high levels of debt to finance excessive imports. A
large portion of the country's exports are commodities, and declining commodity prices have resulted in lower earnings for domestic companies. This reduction translates to less income flowing back into the United Kingdom, increasing its current account deficit.
However, after the British pound declined in value as a result of the Brexit vote that was held on June 23, 2016, the weaker pound decreased the nation's existing debt.
This decrease occurred because overseas dollar earnings were higher for domestic commodity companies, resulting in more cash inflows to the country.
Image by Sabrina Jiang © Investopedia 2020 1. Why should countries trade?
2. Which of the following is a situation in which trade is advantageous?
3. When one producer can create a given amount of output with fewer inputs, what exists?
4. When one producer has a lower opportunity cost of production than another producer for a given item, what exists?
5. Farmer John has a pistachio farm. It takes him 5 hours worth of work to harvest 1 pound of nuts. Farmer Rick also has a pistachio farm. It takes him 10 hours worth of work to harvest 1 pound of nuts. Finally, Farmer Erica owns a third pistachio farm. She can harvest 1 pound of nuts in 2 hours. Who has the absolute advantage in this example?
6. There are three producers. Producer A spends $10 to make a widget. Producer B spends $50 to make
a widget. Producer C spends $4. Who has the absolute advantage?
7. Mechanic A can change a tire in 1 hour and change a sparkplug in 2 hours. Mechanic B can change a tire in 0.5 hours and change a sparkplug in 0.25 hours. Who has the comparative advantage in changing sparkplugs?
8. Rancher Tom can raise 10 goats and 20 pigs in a year. Rancher Joe can raise 20 goats and 100 pigs in a year. Who has the comparative advantage for
raising pigs?
9. What term applies when one option is chosen from among several possibilities?
10. If there are two producers and two products, which of the following cannot happen?
11. When a comparative advantage exists, what should the producer with the comparative advantage do?
12. When an absolute advantage exists, what should the producer with the
absolute advantage do?
13. Is it possible for a producer to have both an absolute advantage and a comparative advantage?
14. What equation describes output?
15. What else does the equation Y = C + I + G + NX describe?
16. In the equation Y = C + I + G + NX, what does Y stand for?
17. What is the equation that describes
net exports?
18. When a country exports and imports the same amount of goods, what is its net exports?
19. When a country exports more than it imports, what is the value of net exports?
20. When a country imports more than it exports, what is the value of the net exports?
21. When net exports are negative, what accounts for the difference?
22. What is the equation that relates net exports to net foreign investment?
23. If a country always imports more than it exports, what will its net foreign investment look like?
24. If a country always exports more than it imports, what will the net foreign investment look like?
25. Which of the following pairs go together?
26.
Which of the following pairs go together?
27. What do you call the number that represents the nominal value of currency in two countries?
28. What do you call the number that compares the real cost of goods between two countries?
29. Which is easier to calculate, the nominal exchange rate or the real exchange rate?
30. Which of the following is not
necessary to calculate the real exchange rate?
31. What is the equation for the real exchange rate?
32. How are the nominal exchange rate and the real exchange rate related?
33. What is the real exchange rate if the domestic price is $5, the foreign price is 3 pounds, and the exchange rate is 1.5?
34. What is the real exchange rate if the domestic price
is $2, the foreign price is 2 pounds, and the exchange rate is 1.5?
35. What is the real exchange rate if the domestic price is $10, the foreign price is 30 pounds, and the exchange rate is 2?
36. What can be determined from the real exchange rate?
37. Which of the following situations is best if you wish to travel to a foreign country?
38. What is the
effect on net exports of an increase in the real exchange rate?
39. When the real exchange rate falls, what is likely to increase?
40. What is the general term for when a government interferes in free trade?
41. Which of the following is not a reason that the government might impose a barrier to trade?
42. What do you call barriers to trade that help
domestic producers?
43. What is it called when the government places limits on the number of a given good that can be imported?
44. What is it called when the government places taxes on imported goods?
45. What is it called when the government gives domestic industries grants to keep them running competitively?
46. What develops when exports exceed
imports?
47. What develops when imports exceed exports?
48. Which of the following is not an effect of a trade deficit?
49. Which of the following is not a way to cure the trade deficit?
50. Which of the following is thought to be related to a high trade deficit?
What two indicators are used to measure a country's international trade?
Two Key Measurements: Balance of Trade and Balance of Payments.
When countries specialize in producing goods they are most efficient at and trade for their other goods from trading partner countries the arrangement demonstrates?
When countries specialize in producing goods they are most efficient at, and trade for their other goods from trading partner countries, the arrangement demonstrates: the Law of Comparative Advantage. Opportunity cost is a key consideration in determining: a company's tax rate.
Which of the following is the most commonly used measure of a country's economic health?
GDP is important because it gives information about the size of the economy and how an economy is performing. The growth rate of real GDP is often used as an indicator of the general health of the economy. In broad terms, an increase in real GDP is interpreted as a sign that the economy is doing well.
What country has absolute advantage?
A clear example of a nation with an absolute advantage is Saudi Arabia, a country with abundant oil supplies that provide it with an absolute advantage over other nations. Other examples include Colombia and its climate—ideally suited to growing coffee—and Zambia, possessing some of the world's richest copper mines.