Perspective 3: What is the Current Account Deficit
There has been much talk recently about the size of New Zealand’s current account deficit and the potential dangers that such a large deficit exposes us to. A former Governor of the reserve Bank, Colin Robertson, recently wrote an article in a weekend paper warning us of the perils that lay ahead if we continued with a current account deficit of around 7% of GDP.
In this article we examine what is meant by the Current Account (and related terms: Capital Account and Balance of Payments). In the next article we try to analyse whether or not a current account deficit is a bad thing.
We start first of all with the concept of Balance of Payments. The Balance of Payments is a systematic statement of all economic transactions between us and the rest of the world. Its components are the Current Account and the Capital Account.
Note that if we had no (economic) dealings with foreigners then there would be no balance of payments, which means no current or capital accounts.
The Current Account includes all items of income and outlay – imports and exports of goods and services, investment income, and transfer payments. The current account balance is simply the balance of the account at any point. It is akin to the net income of a country.
Current account = Merchandise trade balance
+ Services
+ Investment income
+ Transfers
- Merchandise imports and exports consist mainly of primary commodities (food and fuels) and manufactured goods.
- Services consist of items such as shipping, financial services and travel.
- Investment income includes earnings on foreign investments.
- Transfers represent payments not in return for goods in services – for example people sending money to relatives ‘back home’.
The current account may be in surplus or in deficit – hence the terms current account deficit and current account surplus. We are much more acquainted with the former term (deficit) because the subject is rarely raised when we have a current account surplus.
If we have a current account deficit then we must somehow ‘finance’ it. This can only be done by borrowing or reducing foreign assets (which includes running down foreign exchange reserves). After all if you buy something you must either pay for it or owe for it. If you borrow for it then this is the other side of the current account and is called the Capital Account and, as noted above, includes foreign exchange reserves held at the central bank.
Capital account transactions are therefore asset transactions (borrowing and lending) between foreigners and us. If we run a current account deficit (with a particular country) then we essentially have an IOU with that country.
Note that we may simultaneously run current account surpluses with some countries and current account deficits with others.
Fact: The Balance of Payments as a whole must, by definition, show a final zero balance.
To summarise then: running a current account deficit means that we are becoming more indebted to foreigners.
Is this bad? In Perspective 4 we will analyse this question.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
Top of Page
|
