to play devil's advocat - BoP deficit can lead to weakening of domestic economy, international uncompetitiveness and lower living standards therefore in the long run
Agree with Joe - in the short run people's living standards may increase due to a high level of consumer good being bought but in the long run, the country's economy may suffer due to becoming less competetive, meaning living standards may decrease past the point they were before hand.
So no it isn't a bad thing, but if it isn't monitored then it could spiral out of control... maybe?
A current account deficit can lead to higher living standards because it allows consumers to buy a higher level of consumer durables in the short run. However, if the deficit becomes to persistent it could be taken as a sign of a weakening domestic economy and a lack of international compeitiveness. x
If you were spending more money than you were earning, eventually it would back, bite you in the butt, the banks would repossess your house and you'd end up living in a cardboard box on the street.
Doesn't it depend on the size of the persistent deficit? Although a persistent deficit will prevent the economy from taking up other domestic policies that could improve the performance as instead they have to deal with the deficit.
If the deficit was only small, then I don't think it would make a very big difference, even in the long run - where as if it was MASSIVE then it would make a difference almost immediately (I reckon)
A national debt will be high caused by continued deficits could push interest rates up in general, by sucking money out of private investment. That could mean fewer jobs, a squeeze on innovation and tougher times for small business in particular.
"Cool economist".... don't make me laugh!!! I can't really see the deficit making any difference. If it's been a deficit in the Uk for 15years thenit clearly doesnt because the economy steadily grew until the credit crunch
Agree With Willy Edmonds , A deficit would barely effect the overall economy at all. The reason for the credit cruch was the international economy and not the Uk deficit in B of P.
1.A current account deficit is financed through borrowing or foreign investment 2.Borrowing is unsustainable in the long term and countries will be burdened with high interest payments. E.g Russia was unable to pay its foreign debt back in 1998. Other developing countries have experience similar repayment problems Brazil, African c (3rd World debt)
3.Foreigners have an increasing claim on UK assets, which they could desire to be returned at any time. E.g. a severe financial crisis in Japan may cause them to repatriate their investments 4.Export sector may be better at creating jobs
When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these need to be paid back. Common sense suggests that if a country fritters away its borrowed foreign funds in spending that yields no long-term productive gains, then its ability to repay—its basic solvency—might come into question. This is because solvency requires that the country be willing and able to (eventually) generate sufficient current account surpluses to repay what it has borrowed. Therefore, whether a country should run a current account deficit (borrow more) depends on the extent of its foreign liabilities (its external debt) and on whether the borrowing will be financing investment that has a higher marginal product than the interest rate (or rate of return) the country has to pay on its foreign liabilities.
Alex you are talking rubbish 1.Current Account deficit could be used to finance investment E.g. US ran a Current account deficit for a long time as it borrowed to invest in its economy. This enabled higher growth and so it was able to pay its debts back and countries had confidence in lending the US money
2.Japanese investment has been good for UK economy not only did the economy benefit from increased investment but the Japanese firms also helped bring new working practices in which increased labour productivity.
3.With a floating exchange rate a large current account deficit should cause a devaluation which will help reduce the level of the deficit It depend on the size of the budget deficit as a % of GDP, for example the US trade deficit has nearly reached 5% of GDP (02/03) at this level it is concerning economists
But even if the country is intertemporally solvent—meaning that current liabilities will be covered by future revenues—its current account deficit may become unsustainable if it is unable to secure the necessary financing. While some countries (such as Australia and New Zealand) have been able to maintain current account deficits averaging about 4½ to 5 percent of GDP for several decades, others (such as Mexico in 1995 and Thailand in 1997) experienced sharp reversals of their current account deficits after private financing withdrew in the midst of financial crises.
In the 1950s, 60s and 70s, small balance of payments deficits in the UK caused ‘economic crises’ with periods of strong speculative selling of sterling on the foreign exchange markets and much political instability. The devaluation of the pound in 1967 led directly to the resignation of the then Chancellor, James Callaghan. These days, trade deficits of enormous proportions seem to have little effect in global currency markets.
I totally didn't copy and paste this.
So essentially, it seems that balance of payments deficits mattered a lot more 50 years ago than they do now.
alex alderson, the real will trez and the cool economist, aka all will tresider who has been talking to himself has just shown why he's not the cool economist
Free movement of global financial capital has allowed countries to increase their domestic investment beyond what could be financed by a country’s own savings. Increasingly what we want to consume is produced abroad and if a country wants to operate with a sizeable current account deficit, then provided there is a capital account surplus, there is no fundamental economic constraint.
I think that a deficit on the current account can't matter that much as it doesn't necessarily hinder economic growth and there there are reasons for being relaxed about the deficit are: •Partial auto-correction: If some of the deficit is due to strong consumer demand, the deficit will partially-self correct when the economic cycle turns and there is a slowdown in spending •Investment and the supply-side: Some of the deficit may be due to increased imports of new capital and technology which will have a beneficial effect on productivity and competitiveness of producers in home and overseas markets •Capital inflows balance the books: Providing a country has a stable economy and credible economic policies, it should be possible for the current account deficit to be financed by inflows of capital without the need for a sharp jump in interest rates. The UK has run an average annual current account deficit of £10 billion from 1992-2004 and yet the economy has also enjoyed one of the longest sustained periods of growth and falling unemployment during that time.
If the U.K. achieved high economic growth during the early 2000's despite an increasing BOP on the current account, then whether a country has a BOP deficit does not matter, it is the severity of that deficit that could cripple an economy.
A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy. :)
But now Britain is headed for its highest peacetime current account deficit and both household and government spending will have to slow painfully to correct it.
I agree with Evie, and also structural weaknesses may occur as the trade / current account deficit may be a symptom of a wider structural economic problem i.e. a loss of competitiveness in overseas markets, insufficient investment in new capital or a shift in comparative advantage towards other countries.
Britain has been a favoured by an inflow of capital and our relatively high interest rates compared to the USA and the Euro Zone has also attracted large-scale inflows of money into our banking systems. In this way the current account has been financed with few obvious economic problems.
A persistent deficit on the current account of the balance of payments indicates 'fundamental disequilibrium'. However the magnitude of the problem really depends on the size of the deficit itself: the larger the deficit, the larger the problem is going to be. A serious problem is also likely to be caused if the deficit is caused by uncompetitiveness of the country's industries. Even though in the short run, living standards of the country's residents will be raised by imports, in the long-run living standards will actually decrease due to the decline of the country's industries in the face of international competition.
A deficit on the current account is perhaps less of a problem than the media commonly make out (the UK has been in almost constantly in deficit for many many years - someone else can look up the exact figures, and may indicate high levels of inward investment - as is the case for New Zealand). However, a deficit might pose a problem, in that it may well be symtomatic of a fundamnental structural problem for the economy - ie it is not internationally competitive for a reason (maybe insufficient domestic investment in new capital?). Economies bcome reliant on imports, and thus to external shocks such as those of Oil price hikes seen recently. Provided a deficit can be financed with external investment and inward flows on the capital account do not need to be incentivised by hiking interest rates (which might damagegrowth by deflating the economy), a deficit is sustainable. The key thing here is stability and credibility of an economy - as so comonly the case in economics, people's expectations prove to be especially important. R.
The US has ran a huge current account deficit throughout the recession without drastic negative effects on the performance of the economy. If UK businesses can increase their competitiveness in the face of overseas competition and benefit from a depreciation of the exchange rate due to the low rate of interest and make our exports more desirable - the reason for albeit minor growth in the last figures, a deficit is sustainable. As russ says, external investment can also aid the financing of the deficit (and who can disagree with him)
(this is Kate)Depends on : The extent/ permanance of deficit Type of inmports: if imports are items such as semi-manufactured products, good for economy as enable firms to increase production. But if mainly consumer goods, while boosting ST living standards, will result in a LT decline of the country's industries in the face of international competition- lower living standards. If a country is consuming beyond its PPF on items that will no help it to expand its PPF then eventually consumption will have to be constrained to meet interest/ capital repayments at a leter date
A current account deficit has to be financed. This is normally done by attracting inflows of capital from other economies. The UK has struggled to do this recently.
If the deficit is due to excessive consumer demand – a recession or slowdown should help to reduce the problem. Consumers cannot go on spending in excess of their income for ever. Eventually they must control their spending by starting to save again in order to stabilise their own finances.
But Britain has sustained current account deficits of much larger proportions in the past and this has not provoked a major crisis of confidence in the international financial markets. Britain has one of the most open capital markets in the world and the country has proved to be popular for overseas investment - and financing a trade deficit in goods and services has not triggered a sharp collapse in the value of the pound.
In the Short run A deficit might mean that UK households have a better standard of living… but In the Long run a deficit might cause UK businesses to suffer, rising unemployment and falling standards of living!
A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy. ps this is doorbs but i cant set up an account. deli time?
Wezzo and Liv: Yes Harri - A current account deficit is not always a problem. The Pitchford Thesis states that a current account deficit does not matter if it is driven by the private sector. Some feel that this theory has held true for the Australian economy, which has had a persistent current account deficit, yet has experienced economic growth for the past 18 years(1991–2009). From OP
Bill's made a good point that i think some of the younger, less experienced L6th economists may have missed out on. As im sure you are all aware, the balance of payments must in theory balance. As the balance of payments is primarily made up of the current account and and capital account, if there is a persistent deficit on the current account there must be a surplus of equal value on the capital account. Now, the capital account is made up of changes in ownership of assets. So to have a surplus on the capital account to match the deficit on the current account, the UK must sell assets (eg firms) to foreign investors. This means that alot of UK assets will now be owned by foreigners. Do you think that the British public will want all our firms to be owned by foreigners? Probably not. This would also lead to the problem in the long run that money would be lost from the british economy in the form of investment income for foreign economy. Therfore the UK economy would suffer through a lack of growth. X
Also, what happens when that market made of up wealthy foreign investors goes elsewhere in search of a better rate of interest or because they simply lose confidence in the credibility of the economic policies of the country with the persistent deficit? Suddenly that cushion of capital inflows that had long been counted upon is whipped away leaving an un-financed, terminal deficit. Naturally, the country's central bank responds by raising interest rates to try and stabilize the demand for its currency, a consequence of which could be depressed domestic consumption and investment which in turn would inhibit the performance of the economy. Conversely the strategy could be to respond to market forces and capitalise upon the exchange rate depreciation, resulting from the decrease in demand for the country's currency, and cut down the deficit through an increased quantity of exports. However, if the persistent deficit was initially the result of structural decline of the manufacturing/industrial/export sector and not simply because of trends in consumption (a phenomenon sometimes known as ''import psychology'') then the country may take a while to respond with the increased output necessary to capture the renewed competitiveness of its exports on foreign markets. The question would then be: could the economy survive the J of the J curve before seeing its deficit begin to be eaten away.
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ReplyDeleteThis comment has been removed by the author.
ReplyDeleteNo, Britain has run a current account deficit for years and until the financial crisis of 2007 was one of the world's strongest economies
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteI agree with joe
ReplyDeleteto play devil's advocat - BoP deficit can lead to weakening of domestic economy, international uncompetitiveness and lower living standards therefore in the long run
ReplyDeleteAgree with Joe - in the short run people's living standards may increase due to a high level of consumer good being bought but in the long run, the country's economy may suffer due to becoming less competetive, meaning living standards may decrease past the point they were before hand.
ReplyDeleteSo no it isn't a bad thing, but if it isn't monitored then it could spiral out of control... maybe?
This comment has been removed by the author.
ReplyDeleteand "The Amateur Economist" is blantantly amateur... copying what other people are typing before they post it!
ReplyDeletealso I would vote yes :)
give my blog some attention - theamateurecon.blogspot.com
ReplyDeleteA current account deficit can lead to higher living standards because it allows consumers to buy a higher level of consumer durables in the short run. However, if the deficit becomes to persistent it could be taken as a sign of a weakening domestic economy and a lack of international compeitiveness. x
ReplyDeleteI would vote no (Y)
ReplyDeleteIf you were spending more money than you were earning, eventually it would back, bite you in the butt, the banks would repossess your house and you'd end up living in a cardboard box on the street.
Why should it be different for countries?
Oh is this what i'm missing out on in class then. i am skiving.
ReplyDeleteDoesn't it depend on the size of the persistent deficit? Although a persistent deficit will prevent the economy from taking up other domestic policies that could improve the performance as instead they have to deal with the deficit.
ReplyDeletei agree with Lucy - small persistent deficit doesnt seem to be much of an issue
ReplyDeleteAgree with Lucy - she is my idol...
ReplyDeleteIf the deficit was only small, then I don't think it would make a very big difference, even in the long run - where as if it was MASSIVE then it would make a difference almost immediately (I reckon)
A national debt will be high caused by continued deficits could push interest rates up in general, by sucking money out of private investment. That could mean fewer jobs, a squeeze on innovation and tougher times for small business in particular.
ReplyDeleteThis comment has been removed by the author.
ReplyDelete"Cool economist".... don't make me laugh!!!
ReplyDeleteI can't really see the deficit making any difference. If it's been a deficit in the Uk for 15years thenit clearly doesnt because the economy steadily grew until the credit crunch
Agree With Willy Edmonds , A deficit would barely effect the overall economy at all. The reason for the credit cruch was the international economy and not the Uk deficit in B of P.
ReplyDelete"VOTE YES TO AV"
1.A current account deficit is financed through borrowing or foreign investment
ReplyDelete2.Borrowing is unsustainable in the long term and countries will be burdened with high interest payments. E.g Russia was unable to pay its foreign debt back in 1998. Other developing countries have experience similar repayment problems Brazil, African c (3rd World debt)
3.Foreigners have an increasing claim on UK assets, which they could desire to be returned at any time. E.g. a severe financial crisis in Japan may cause them to repatriate their investments
4.Export sector may be better at creating jobs
When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these need to be paid back. Common sense suggests that if a country fritters away its borrowed foreign funds in spending that yields no long-term productive gains, then its ability to repay—its basic solvency—might come into question. This is because solvency requires that the country be willing and able to (eventually) generate sufficient current account surpluses to repay what it has borrowed. Therefore, whether a country should run a current account deficit (borrow more) depends on the extent of its foreign liabilities (its external debt) and on whether the borrowing will be financing investment that has a higher marginal product than the interest rate (or rate of return) the country has to pay on its foreign liabilities.
ReplyDeleteAlex you are talking rubbish
ReplyDelete1.Current Account deficit could be used to finance investment
E.g. US ran a Current account deficit for a long time as it borrowed to invest in its economy. This enabled higher growth and so it was able to pay its debts back and countries had confidence in lending the US money
2.Japanese investment has been good for UK economy not only did the economy benefit from increased investment but the Japanese firms also helped bring new working practices in which increased labour productivity.
3.With a floating exchange rate a large current account deficit should cause a devaluation which will help reduce the level of the deficit
It depend on the size of the budget deficit as a % of GDP, for example the US trade deficit has nearly reached 5% of GDP (02/03) at this level it is concerning economists
But even if the country is intertemporally solvent—meaning that current liabilities will be covered by future revenues—its current account deficit may become unsustainable if it is unable to secure the necessary financing. While some countries (such as Australia and New Zealand) have been able to maintain current account deficits averaging about 4½ to 5 percent of GDP for several decades, others (such as Mexico in 1995 and Thailand in 1997) experienced sharp reversals of their current account deficits after private financing withdrew in the midst of financial crises.
ReplyDeleteI think yes, because why would we be learning about it if it had no effect on the economy?? simple logic
ReplyDeleteIn the 1950s, 60s and 70s, small balance of payments deficits in the UK caused ‘economic crises’ with periods of strong speculative selling of sterling on the foreign exchange markets and much political instability. The devaluation of the pound in 1967 led directly to the resignation of the then Chancellor, James Callaghan. These days, trade deficits of enormous proportions seem to have little effect in global currency markets.
ReplyDeleteI totally didn't copy and paste this.
So essentially, it seems that balance of payments deficits mattered a lot more 50 years ago than they do now.
usefull comment edd
ReplyDeletealex alderson, the real will trez and the cool economist, aka all will tresider who has been talking to himself has just shown why he's not the cool economist
ReplyDeleteBants x
ReplyDeleteFree movement of global financial capital has allowed countries to increase their domestic investment beyond what could be financed by a country’s own savings. Increasingly what we want to consume is produced abroad and if a country wants to operate with a sizeable current account deficit, then provided there is a capital account surplus, there is no fundamental economic constraint.
ReplyDeleteA to the L to the E to the X to the S to the A to the L to the M to the O to the N to the D ....
ReplyDeleteI think that a deficit on the current account can't matter that much as it doesn't necessarily hinder economic growth and there there are reasons for being relaxed about the deficit are:
ReplyDelete•Partial auto-correction: If some of the deficit is due to strong consumer demand, the deficit will partially-self correct when the economic cycle turns and there is a slowdown in spending
•Investment and the supply-side: Some of the deficit may be due to increased imports of new capital and technology which will have a beneficial effect on productivity and competitiveness of producers in home and overseas markets
•Capital inflows balance the books: Providing a country has a stable economy and credible economic policies, it should be possible for the current account deficit to be financed by inflows of capital without the need for a sharp jump in interest rates. The UK has run an average annual current account deficit of £10 billion from 1992-2004 and yet the economy has also enjoyed one of the longest sustained periods of growth and falling unemployment during that time.
If the U.K. achieved high economic growth during the early 2000's despite an increasing BOP on the current account, then whether a country has a BOP deficit does not matter, it is the severity of that deficit that could cripple an economy.
ReplyDeleteA BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy. :)
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteThis comment has been removed by the author.
ReplyDeletehttp://www.guardian.co.uk/business/2006/mar/30/2
ReplyDeleteThis article indicates that the Uk had a huge deficit in 2006... Probably too early to be connected to the recession...
OR WAS IT THE BEGINNING OF THE END
OR AM I WILLY TRESSIDIDDLE
But now Britain is headed for its highest peacetime current account deficit and both household and government spending will have to slow painfully to correct it.
ReplyDeleteYES!!! it will decrease a country's foreign currency reserves and they are not endless pots... :)
ReplyDeleteNews: Balance of payments deficit increased because Will Tressider keeps importing crayons to eat
ReplyDeleteI agree with Evie, and also structural weaknesses may occur as the trade / current account deficit may be a symptom of a wider structural economic problem i.e. a loss of competitiveness in overseas markets, insufficient investment in new capital or a shift in comparative advantage towards other countries.
ReplyDeleteBritain has been a favoured by an inflow of capital and our relatively high interest rates compared to the USA and the Euro Zone has also attracted large-scale inflows of money into our banking systems. In this way the current account has been financed with few obvious economic problems.
ReplyDeleteThe bop is important especially if it is a defecit. and whoever is pretending to be me is extreamily immature (alex alderson)
ReplyDeleteA persistent deficit on the current account of the balance of payments indicates 'fundamental disequilibrium'.
ReplyDeleteHowever the magnitude of the problem really depends on the size of the deficit itself: the larger the deficit, the larger the problem is going to be. A serious problem is also likely to be caused if the deficit is caused by uncompetitiveness of the country's industries. Even though in the short run, living standards of the country's residents will be raised by imports, in the long-run living standards will actually decrease due to the decline of the country's industries in the face of international competition.
peter preston is my idol.... i will agree to whatever he says <3
ReplyDeleteA deficit on the current account is perhaps less of a problem than the media commonly make out (the UK has been in almost constantly in deficit for many many years - someone else can look up the exact figures, and may indicate high levels of inward investment - as is the case for New Zealand).
ReplyDeleteHowever, a deficit might pose a problem, in that it may well be symtomatic of a fundamnental structural problem for the economy - ie it is not internationally competitive for a reason (maybe insufficient domestic investment in new capital?). Economies bcome reliant on imports, and thus to external shocks such as those of Oil price hikes seen recently.
Provided a deficit can be financed with external investment and inward flows on the capital account do not need to be incentivised by hiking interest rates (which might damagegrowth by deflating the economy), a deficit is sustainable. The key thing here is stability and credibility of an economy - as so comonly the case in economics, people's expectations prove to be especially important. R.
The US has ran a huge current account deficit throughout the recession without drastic negative effects on the performance of the economy. If UK businesses can increase their competitiveness in the face of overseas competition and benefit from a depreciation of the exchange rate due to the low rate of interest and make our exports more desirable - the reason for albeit minor growth in the last figures, a deficit is sustainable. As russ says, external investment can also aid the financing of the deficit (and who can disagree with him)
ReplyDelete(this is Kate)Depends on :
ReplyDeleteThe extent/ permanance of deficit
Type of inmports: if imports are items such as semi-manufactured products, good for economy as enable firms to increase production. But if mainly consumer goods, while boosting ST living standards, will result in a LT decline of the country's industries in the face of international competition- lower living standards. If a country is consuming beyond its PPF on items that will no help it to expand its PPF then eventually consumption will have to be constrained to meet interest/ capital repayments at a leter date
A current account deficit has to be financed. This is normally done by attracting inflows of capital from other economies. The UK has struggled to do this recently.
ReplyDeleteIf the deficit is due to excessive consumer demand – a recession or slowdown should help to reduce the problem. Consumers cannot go on spending in excess of their income for ever. Eventually they must control their spending by starting to save again in order to stabilise their own finances.
But Britain has sustained current account deficits of much larger proportions in the past and this has not provoked a major crisis of confidence in the international financial markets. Britain has one of the most open capital markets in the world and the country has proved to be popular for overseas investment - and financing a trade deficit in goods and services has not triggered a sharp collapse in the value of the pound.
In the Short run A deficit might mean that UK households have a better standard of living…
ReplyDeletebut In the Long run a deficit might cause UK businesses to suffer, rising unemployment and falling standards of living!
Yes Jess, I agree, but the UK has run large current account deficits in recent years with barely any effect on the overall performance of the economy.
ReplyDeleteA BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating, and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy. ps this is doorbs but i cant set up an account. deli time?
ReplyDelete^ from dorbs
ReplyDeleteWezzo and Liv:
ReplyDeleteYes Harri - A current account deficit is not always a problem. The Pitchford Thesis states that a current account deficit does not matter if it is driven by the private sector. Some feel that this theory has held true for the Australian economy, which has had a persistent current account deficit, yet has experienced economic growth for the past 18 years(1991–2009). From OP
Bill's made a good point that i think some of the younger, less experienced L6th economists may have missed out on. As im sure you are all aware, the balance of payments must in theory balance. As the balance of payments is primarily made up of the current account and and capital account, if there is a persistent deficit on the current account there must be a surplus of equal value on the capital account. Now, the capital account is made up of changes in ownership of assets. So to have a surplus on the capital account to match the deficit on the current account, the UK must sell assets (eg firms) to foreign investors. This means that alot of UK assets will now be owned by foreigners. Do you think that the British public will want all our firms to be owned by foreigners? Probably not. This would also lead to the problem in the long run that money would be lost from the british economy in the form of investment income for foreign economy. Therfore the UK economy would suffer through a lack of growth. X
ReplyDeleteAlso, what happens when that market made of up wealthy foreign investors goes elsewhere in search of a better rate of interest or because they simply lose confidence in the credibility of the economic policies of the country with the persistent deficit? Suddenly that cushion of capital inflows that had long been counted upon is whipped away leaving an un-financed, terminal deficit. Naturally, the country's central bank responds by raising interest rates to try and stabilize the demand for its currency, a consequence of which could be depressed domestic consumption and investment which in turn would inhibit the performance of the economy. Conversely the strategy could be to respond to market forces and capitalise upon the exchange rate depreciation, resulting from the decrease in demand for the country's currency, and cut down the deficit through an increased quantity of exports. However, if the persistent deficit was initially the result of structural decline of the manufacturing/industrial/export sector and not simply because of trends in consumption (a phenomenon sometimes known as ''import psychology'') then the country may take a while to respond with the increased output necessary to capture the renewed competitiveness of its exports on foreign markets. The question would then be: could the economy survive the J of the J curve before seeing its deficit begin to be eaten away.
ReplyDelete