6.5 Policies to Correct Imbalances in the Current Account of the Balance of Payments

Objective 1: Why Governments Want a Stable Current Account

What Is the Current Account?

The current account is part of the balance of payments. It records all money flowing in and out of a country from trade in goods and services. In simple terms:

• If a country exports (sells to other countries) more than it imports (buys from other countries), it has a current account surplus — money is flowing in.
• If a country imports more than it exports, it has a current account deficit — money is flowing out.

The balance can be written as: Current Account Balance = Exports (X) − Imports (M)

Problems with a Large Current Account Deficit (Importing far more than exporting)

• Foreign debt builds up. When a country consistently imports more than it exports, it needs to borrow money from abroad to pay for the extra imports. Over time, this debt grows and becomes a burden.
• Loss of foreign reserves. The government may have to use up its savings of foreign currency (called foreign reserves) to cover the gap.
• Domestic industries suffer. If households are buying lots of imported goods, local factories and businesses may lose customers, leading to lower output (GDP falls) and higher unemployment.
• Imported inflation. If a country imports a lot, and the cost of those imports rises, it can push up prices inside the country — this is called imported inflation (inflation caused by rising import prices).
• Weaker currency. A persistent deficit puts downward pressure on the exchange rate, making imports even more expensive.
• Bad international relations. Trading partners may become frustrated and impose trade restrictions in retaliation.