Persistent Current Account

Deficits
Unit 15 - Lesson 5

Learning outcomes:
Discuss the implications of a persistent current account deficit,
referring to factors including foreign ownership of domestic assets,
exchange rates, interest rates, indebtedness, potential output,
international credit ratings and demand management.

Current Account Deficits

Most countries in the world have a current account deficit.
Current Account Deficits mixed with Current Account Surpluses do not
generally pose problems for a country.
Persistent Current Account Deficits can pose problems for a country due
to the fact they do not have an unlimited amount of foreign currency
reserves to Balance the Balance of Payments.
Therefore it must:
1. Borrow from other countries
2. Sell some of its Physical Assets

Persistent Current Account Deficit

Financed by loans from abroad:
Current Account Deficits paid for by Financial Account Surpluses through
borrowing can create the following:
1. Higher Interest Rate - Attracts Foreign money creating Financial
Account Surplus - HOWEVER domestic spending decreases domestic investment spending decreases - decrease in AD - can
cause recession.
2. High Indebtedness - risk of having too much debt - default (not able
to pay back) - risk of serious currency depreciation.

Financed by loans from abroad

1. Painful Government Action - must pursue contractionary
policies - decreases domestic consumptions - decreases
domestic investment - can lead to a recession
2. Lower Economic Growth for reasons explained above decrease in consumptions - decrease in investment decrease in AD.
3. Lower Standard of Living due to reasons explained
above - decrease in consumptions - decrease in
investment - decrease in AD.

Though not all borrowing is bad...

Borrowing can lead to Economic Growth - if per capita output increases income increases - can lead to increased consumption - increase in AD Economic Growth.
Can happen if:
1. Current Account Deficit remains relatively small
2. Borrowed funds are used to finance imports of Capital Goods rather than
for consumption purposes
3. Some production is steered towards export industries - helps with export
earnings - allows for countries to be able to pay back loans.
Rationale for lending money to Developing countries...transition economies

Sale of Domestic Assets

Persistent Account Deficit will result in Financial Account Surplus.
This Financial Account Surplus can be financed by the sale of Domestic
Assets (land, factories, building, stock, & bonds)
Countries that achieve Financial Account Surpluses through this means
do not incur debt that must be paid back.
The United States finances Balances it Current Account Deficit
through the sale of Domestic Assets.

Problems that may arise.

Selling assets to achieve Current Account Surplus:
1. Higher Interest Rates to attract Foreign Investors - decrease in
domestic consumption - decrease in domestic investment - can lead
to a recession.
2. High Indebtedness - continued sales of domestic assets to
foreigners - may be difficult to regain assets.
3. Depreciating Exchange Rate - Persistent Current Account Deficits More Imports - Downward pressure on the currency.
4. Poor International Credit Ratings - loss of confidence in the
currency.

Does not all have to be bad...

Not necessarily bad
If the country can achieve Economic Growth that allows increases in per
capita output and increase in income.
This combination looks to decrease the Current Account Deficit thus
reducing the amount necessary to fund the Financial Account Surplus.
Decrease in the amount necessary to fund the Financial Account can be
used to purchase the Domestic Assets from foreigners.