UNIT 6

CHAPTER 6.4
CURRENT ACCOUNT OF
BALANCE OF PAYMENTS
Current account is a component of a
country's balance of payments
recording transactions relating to
trade in goods and services, primary
and secondary income essentially
measuring a country's net earnings
from its international transactions
COMPONENTS OF CURRENT ACCOUNT
TRADE IN
TRADE IN SERVICES
GOODS (INVISIBLE
(VISIBLE TRADE) TRADE)
Export of goods Export of
– Import of services –
goods Import of
services

PRIMARY INCOME SECONDARY INCOME

income that people of transfers of income
an economy receive between residents
and non-residents that
for their direct
don't involve any
participation in the
goods or services in
production process, return. Examples
including wages, include Aid,
profits, dividends and donations,
interest remittances
TRADE IN GOODS = Export of goods – Import of goods

Also known as VISIBLE TRADE or TRADE IN GOODS

BALANCE, is the difference between export of goods and
import of goods.

Trade in goods deficit is when import expenditure on goods

exceed the export revenue from goods

Trade in goods surplus is when export revenue from goods

exceed the import expenditure on goods
TRADE IN SERVICES = Export of services – import of services

Also known as INVISIBLE TRADE or TRADE IN SERVICES

BALANCE, is the difference between export of services and
import of services.

Trade in services deficit is when import expenditure on

services exceed the export revenue from services

Trade in services surplus is when export revenue from

services exceed the import expenditure on services
PRIMARY INCOME
It is the difference
between inflow (receipts)
of interest, dividends,
profits and wages and
outflow (payments) of
interest, dividends,
profits and wages.

If the inflow < outflow If the inflow > outflow

NET NEGATIVE NET POSITIVE
PRIMARY PRIMARY
(INVESTMENT) (INVESTMENT)
INCOME INCOME
SECONDARY INCOME
It is the difference between
inflow (receipts) of aid,
donations and remittances
and outflow (payments) of
aid, donations and
remittances.

If the inflow < outflow If the inflow > outflow

NET NEGATIVE NET POSITIVE
SECONDARY SECONDARY
(TRANSFER) INCOME (TRANSFER) INCOME
CURRENT ACCOUNT SURPLUS

When the revenue from export of goods and services exceeds the expenditure on
import of goods and services

When the inflow (receipts) from primary income and secondary income is higher
than the outflow (payments) of primary income and secondary income

Sum of credit items is greater than the sum of debit items

CAUSES OF CURRENT ACCOUNT SURPLUS
Exports are greater than imports when demand for
exports are greater than demand for imports.
Demand higher price due to higher cost of production Demand lower price due to lower cost of production
for for
Imports Lower quality due to lower labour productivity
Exports higher quality due to higher labour
are are productivity
lower higher
due to: Higher trade restrictions due to: lower trade restrictions

Lower incomes of people in the country due to Higher incomes of people abroad due to higher
lower economic growth or low employment levels economic growth or high employment levels

Lower exchange rate (Currency depreciation) Lower exchange rate (Currency depreciation)

Primary income inflow (receipts) is greater than outflow (payments) - net positive primary (investment) income

Secondary income inflow (receipts) is greater than outflow (payments) - net positive secondary (transfer) income
CONSEQUENCES OF CURRENT ACCOUNT SURPLUS
(Exports>Imports)
POSITIVE NEGATIVE
A surplus in one country may
Since exports are higher, create a deficit in another Exports are higher – rise in
output will rise – rise in country - other countries net exports – AD rises – Lower imports – less choice
GDP/economic growth – Exports are higher – rise in may impose protectionist demand pull inflation if for consumers – lower living
increase in employment – net exports – AD rises policies to prevent future economy is operating at full standards for consumers
higher incomes and living deficits – affects the employment
standards exporting county

Currency appreciates due to

Higher exports – more current account surplus - this
demand for the country’s Higher exports of raw Higher exports –
Higher exports – more reduces net exports
currency – currency materials – faster depletion opportunity cost as
international increasing unemployment -
appreciates – can be a sign of resources domestic demand is not met
can worsen current account
competitiveness for firms
of strong economy – deficit in the long run
attracts investments

If fewer imports are being

purchased because trade
Debt will reduce as imports restrictions are introduced
are lower – need not have there may be retaliation -
to borrow much to finance with tariffs/quotas being
for the imports imposed on exports
POLICIES TO CORRECT CURRENT ACCOUNT SURPLUS
Note: Fall/correction of current account surplus means imports rise and exports fall

CONTRACTIONARY FISCAL AND MONETARY POLICY to reduce exports

• Reduction in government spending such as on subsidies/education and increase in corporate taxes –
increases cost of production for firms – reduces output – reduces exports – leads to fall in current account
surplus
• Rise in interest rate and fall in money supply – reduces borrowing and investment by firms – output falls –
exports fall – current account surplus falls
• Rise in exchange rate makes exports expensive and leads to a fall in its demand – reduces current
account surplus

REMOVING PROTECTIONIST POLICY to increase imports

• Removing/reducing tariffs, embargos or increasing quotas – increases imports – reduces current account
surplus

Policies to be explained in detail

CURRENT ACCOUNT DEFICIT

When the expenditure on import of goods and services exceeds the revenue from
export of goods and services

When the outflow (payments) of primary income and secondary income is

higher than the inflow (receipts) from primary income and secondary income

Sum of debit items is greater than the sum of credit items

 CAUSES OF CURRENT ACCOUNT DEFICIT
Imports are greater than exports when demand for imports are greater
than demand for exports.
Demand lower price due to lower cost of production Demand higher price due to higher cost of production
for for
Imports higher quality due to higher labour productivity Exports Lower quality due to lower labour productivity
are are
higher lower trade restrictions lower Higher trade restrictions
due to: due to:
Higher incomes of people in the country due to Lower incomes of people abroad due to lower
higher economic growth or high employment levels economic growth or low employment levels
Higher exchange rate (Currency Appreciation) Higher exchange rate (Currency Appreciation)

Primary income inflow (receipts) is less than outflow (payments) - net negative primary (investment) income

Secondary income inflow (receipts) is less than outflow (payments) - net negative secondary (transfer) income
CONSEQUENCES OF CURRENT ACCOUNT DEFICIT
(Imports>Exports)
POSITIVE NEGATIVE
Exports are less and imports are more – fall in net exports – AD falls
Higher choice of goods for
Less harmful if the deficit • Fall in GDP/economic growth
consumers as imports are
is temporary or if the • Fall in international competitiveness for firms
higher – living standards
deficit is low
are higher • Rise in cyclical unemployment – fall in incomes and living
standards – higher government spending on unemployment
benefits

Current account deficit –

If deficit is due to import of
higher imports than
raw materials, it can lead
exports – fall in net
to more output and Higher imports – may Currency depreciation can
exports – fall in AD – fall in
exports in the long run
demand pull inflation increase the need to borrow reduce the confidence in the
more to make payments for economy – may not attract
the imports investments/MNCs
A deficit in current account will lead to currency depreciation if the
country has a floating exchange rate system – exports become
cheaper and imports become expensive in the long run – can have
multiple benefits such as:
•Higher output and GDP/economic growth
•More employment
•More international competitiveness for firms
 POLICIES TO CORRECT CURRENT ACCOUNT DEFICIT
Note: Fall/correction/reduction of current account deficit means exports rise and imports fall

EXPANSIONARY FISCAL AND MONETARY POLICY – to increase exports

• Increase in government spending such as subsidies and decrease in corporate taxes – firms can produce more
output as their cost of production falls – exports rises – leads to fall in current account deficit
• Fall in interest rate and Rise in money supply – increases investment by firms – output rises – exports increase –
current account deficit falls
• Fall in exchange rate makes exports cheaper and leads to a rise in its demand – reduces current account deficit
CONTRACTIONARY FISCAL AND MONETARY POLICY – to decrease imports
• Increase in income tax – reduces disposable income – reduces spending on imports - fall in current account
deficit
• Rise in interest rate – increases cost of borrowing – reduces consumer borrowing - reduces spending on imports
- fall in current account deficit
• Fall in money supply - reduces bank lending - reduces consumer borrowing - reduces spending on imports - fall
in current account deficit

Policies to be explained in detail

POLICIES TO CORRECT CURRENT ACCOUNT DEFICIT
Note: Fall/correction/reduction of current account deficit means exports rise and imports fall
DRAWBACKS OF PROTECTIONIST
IMPOSING POLICY MEASURES
PROTECTIONIST POLICY
Trade protection may provoke retaliation if other
Embargoes countries impose trade restrictions - the current
will stop Trade account may not improve
Tariffs may
imports of protection
increase Quotas will
certain may prevent
import prices reduce the Trade protection may discourage firms from becoming
products - other
– demand for quantity of efficient as they may become over reliant on
may cause countries protection - this will mean the deficit will continue
imports imports – fall
lower import from
decrease – in current
expenditure - dumping
fall in current account
reducing a their output –
account deficit Trade protection can reduce the import of raw
current reduces
deficit materials and can affect production
account imports
deficit
Trade protection may restrict the import of goods
which the country may not be able to produce
Other measures such as exchange controls, quality domestically
standards can also be explained