6.4. Current account of the balance of payments
- Syllabus
- 0455–2027–2028
- Topic
- 6.4
- Level
- —
Learning objectives
6.4.1Structure of the current account of the balance of payments• components of the current account of the balance of payments:• trade in goods• trade in services• primary income• secondary income• calculation of deficits and surpluses on the current account of the balance of payments and its component sections6.4.2Causes of current account deficit and surplus• reasons for current account deficits and surpluses6.4.3Consequences of current account deficit and surplus• impact on GDP, employment, inflation and foreign exchange rate6.4.4Policies to achieve balance of payments stability• the range of policies available to achieve balance of payments stability and their effectiveness
Build and calculate the current account
The current account records recurring flows of goods, services, income and transfers between a country and the rest of the world. Money received is a credit (+); money paid is a debit (−).
| Component | What it records | Balance |
|---|---|---|
| trade in goods | exports and imports of physical products | goods exports − goods imports |
| trade in services | services such as tourism, transport, insurance and banking | service exports − service imports |
| primary income | wages, profits, interest and dividends earned across borders | income received − income paid |
| secondary income | one-way current transfers such as remittances, aid and contributions | transfers received − transfers paid |
currentaccountbalance=goodsbalance+servicesbalance+netprimaryincome+netsecondaryincome
Example: goods −30bn,services+20bn, primary income +8bnandsecondaryincome−3bn give −30 + 20 + 8 − 3 = −$5bn: a current account deficit.
A deficit is a negative balance, not simply 'more physical imports than exports'. A goods deficit can be outweighed by surpluses in services or income. Purchases of overseas assets are not current-account transactions.
Explain current account deficits and surpluses
A current account deficit occurs when total current-account debits exceed credits; a surplus occurs when credits exceed debits. The cause may come from trade, primary income or secondary income.
| Change | Likely pressure on the current account | Mechanism |
|---|---|---|
| higher domestic income | towards deficit | households and firms can buy more imports |
| higher income in trading partners | towards surplus | foreign demand for exports may rise |
| higher domestic inflation or weaker productivity/quality | towards deficit | exports lose competitiveness and imports become relatively attractive |
| currency appreciation | often towards deficit | export prices rise abroad while import prices fall at home |
| lower trade restrictions at home | towards deficit | imports become easier or cheaper to buy |
| stronger investment income, remittances or aid inflows | towards surplus | primary or secondary income credits rise |
Reverse changes tend to move the balance the other way: stronger competitiveness, higher productivity, depreciation or weaker domestic demand may reduce a deficit or increase a surplus.
Do not explain the whole current account only with exports and imports of goods. Services, primary income and secondary income can reverse the trade balance's effect.
Evaluate the consequences of current account balances
A current account balance affects total demand and currency flows, but its impact depends on its size, duration and cause.
| Outcome | Persistent deficit pressure | Persistent surplus pressure |
|---|---|---|
| GDP | lower net exports can reduce total demand and growth | higher net exports can raise total demand and growth |
| employment | weaker domestic output may reduce labour demand | stronger output may increase labour demand |
| inflation | weaker demand may reduce demand-pull inflation, but depreciation can raise import costs | stronger demand may cause demand-pull inflation, while appreciation can lower import costs |
| exchange rate | selling domestic currency to finance net outflows can cause depreciation | foreign demand for the currency can cause appreciation |
A deficit may finance productive raw materials and capital goods that raise future capacity, so it is not automatically harmful. A surplus may create jobs but can reduce domestic consumption, exhaust resources or appreciate the currency and weaken future export competitiveness.
Judge the balance in context: distinguish a small temporary imbalance from a large persistent one, and identify whether imports support consumption or future production.
Choose policies for balance of payments stability
Policy should target the cause of an unwanted current account imbalance. A measure is effective only if it changes current-account credits or debits enough without creating larger costs elsewhere.
| Policy route for a deficit | Intended mechanism | Main limit |
|---|---|---|
| reduce total demand: higher taxes, lower government spending or higher interest rates | lower income and spending reduce import demand | may reduce GDP and employment; imports may be necessities |
| tariffs or import quotas | raise import prices or restrict quantities, switching demand to home output | retaliation, smuggling, higher input prices and no domestic substitutes |
| producer/export subsidies | lower costs or improve quality, raising competitiveness | fiscal cost, dependency, inefficiency and retaliation |
| currency depreciation | exports become cheaper abroad and imports dearer at home | depends on price elasticity, inflation, capacity and time |
| supply-side policies: education, infrastructure and productive investment | higher productivity lowers unit costs and improves quality | slow, costly and ineffective if foreign demand is weak |
For an unwanted surplus, policies can work in reverse: stimulate domestic demand, reduce import restrictions or allow appreciation so imports rise and export demand moderates.
Combine policies when causes differ. Supply-side improvement may be more sustainable than permanent protection, while short-run demand or exchange-rate measures can work faster. Check elasticity, time lags, spare capacity, trading-partner retaliation and effects on inflation, output and employment.
Balance of payments stability does not mean forcing the current account to equal zero every year. The aim is to avoid an imbalance that is large, persistent or damaging.