Current account
Encyclopedia
In economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, the current account is one of the two primary components of the balance of payments
Balance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
, the other being the capital account
Capital account
The current and capital accounts make up a country's balance of payment . Together these three accounts tell a story about the state of an economy, its economic outlook and its strategies for achieving its desired goals...
. The current account is the sum of the balance of trade
Balance of trade
The balance of trade is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports...
(exports minus imports of goods and services), net factor income
Factor income
Factor income is income derived from selling the services of factors of production. In the case of labour, this means wages, plus the part of the incomes of the self-employed which is a reward for their own labour. Income from land is rents, including part of the incomes of the self-employed, and...
(such as interest and dividends) and net transfer payments (such as foreign aid).
The current account balance is one of two major measures of the nature of a country's foreign trade (the other being the net capital outflow
Net Capital Outflow
Net Capital Outflow is the net flow of funds being invested abroad by a country during a certain period of time . A positive NCO means that the country invests outside more than the world invests in it; a negative one, that the world invests in the country more than the country invests in the world...
). A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period.
The balance of trade is the difference between a nation's exports of goods and services and its imports of goods and services, if all financial transfers, investments and other components are ignored. A Nation is said to have a trade deficit if it is importing more than it exports.
Positive net sales abroad generally contributes to a current account surplus; negative net sales abroad generally contributes to a current account deficit. Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports. This however is not always the case with secluded economies such as that of Australia featuring an income deficit larger than its trade deficit.
The net factor income
Factor income
Factor income is income derived from selling the services of factors of production. In the case of labour, this means wages, plus the part of the incomes of the self-employed which is a reward for their own labour. Income from land is rents, including part of the incomes of the self-employed, and...
or income account, a sub-account of the current account, is usually presented under the headings income payments as outflows, and income receipts as inflows. Income refers not only to the money received from investments made abroad (note: investments are recorded in the capital account
Capital account
The current and capital accounts make up a country's balance of payment . Together these three accounts tell a story about the state of an economy, its economic outlook and its strategies for achieving its desired goals...
but income from investments is recorded in the current account) but also to the money sent by individuals working abroad, known as remittances
Remittances
A remittance is a transfer of money by a foreign worker to his or her home country. Note that in 19th century usage a remittance man was someone exiled overseas and sent an allowance on condition that he not return home....
, to their families back home. If the income account is negative, the country is paying more than it is taking in interest, dividends, etc.
The various subcategories in the income account are linked to specific respective subcategories in the capital account, as income is often composed of factor payments from the ownership of capital (assets) or the negative capital (debts) abroad. From the capital account, economists and central banks determine implied rates of return on the different types of capital. The United States, for example, gleans a substantially larger rate of return from foreign capital than foreigners do from owning United States capital.
In the traditional accounting of balance of payments, the current account equals the change in net foreign assets
Net foreign assets
In economics, the concept of net foreign assets relates to balance of payment identity.The net foreign asset position of a country is the value of the assets that country owns abroad, minus the value of the domestic assets owned by foreigners...
. A current account deficit implies a paralleled reduction of the net foreign assets.
- current account = changes in net foreign assets
Reducing current account deficits
Action to reduce a substantial current account deficit usually involves increasing exports (goods going out of a country and entering abroad countries) or decreasing imports (goods coming from a foreign country into a country). Firstly, this is generally accomplished directly through import restrictions, quotas, or duties (though these may indirectly limit exports as well), or subsidizing exports. Influencing the exchange rate to make exports cheaper for foreign buyers will indirectly increase the balance of payments. Also, Currency warsCurrency Wars
Currency Wars by Song Hong bing, also known as The Currency War, is a bestselling book in China, reportedly selling over 200,000 copies and is reportedly being read by many senior level government and business leaders in China...
, a phenomenon evident in post recessionary markets is a protectionist policy, whereby countries devalue their currencies to ensure export competitiveness. Secondly, current account deficit are reduced by promoting investor friendly environment, i.e., foreign direct investment
Foreign direct investment
Foreign direct investment or foreign investment refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor.. It is the sum of equity capital,other long-term capital, and short-term capital as shown in...
(FDI), foreign institutional investors (FII), the income from these foreign investments positively contributes to current account. Thirdly, adjusting government spending to favor domestic suppliers is also effective.
Less obvious methods to reduce a current account deficit include measures that increase domestic savings (or reduced domestic borrowing), including a reduction in borrowing by the national government.
The Pitchford thesis
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.A Current Account Deficit largely consists of repayments of public debt, and that debt consists of many individual transactions. Pitchford asserts that since each of these transactions were individually considered financially sound when they were made, their aggregate effect (the Current Account Deficit) is also sound.
Some feel that this theory has held true for the Australian economy
Economy of Australia
The economy of Australia is a developed, modern market economy with a GDP of approximately US$1.23 trillion. In 2011, it was the 13th largest national economy by nominal GDP and the 17th largest measured by PPP adjusted GDP, representing about 1.7% of the World economy. Australia was also ranked...
, which has had a persistent current account deficit, yet has experienced economic growth for the past 18 years (1991–2009).
Interrelationships in the balance of payments
Absent changes in official reserves, the current account is the mirror image of the sum of the capital and financial accounts. One might then ask: Is the current account driven by the capital and financial accounts or is it vice versa? The traditional response is that the current account is the main causal factor, with capital and financial accounts simply reflecting financing of a deficit or investment of funds arising as a result of a surplus. However, more recently some observers have suggested that the opposite causal relationship may be important in some cases. In particular, it has controversially been suggested that the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
current account deficit is driven by the desire of international investors to acquire U.S. assets (See Ben Bernanke
Ben Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
, William Poole links below [which ones exactly? missing reference number/link]). However, the main viewpoint undoubtedly remains that the causative factor is the current account and that the positive financial account reflects the need to finance the country's current account deficit.
U.S. account deficits
Since 1989, the current account deficit of the United States have been increasingly large, reaching close to 7% of the GDP in 2006. New evidences, however, suggest that the U.S. current account deficits are being mitigated by positive valuation effectsValuation effects
Valuation Effects is a term in economics.Valuation Effects of a country are the changes in the value of assets it holds abroad, minus the changes in the value of domestic assets held by foreign investors.- Valuation Effects:...
. That is, the U.S. assets overseas are gaining in value relative to the domestic assets held by foreign investors. The U.S. net foreign assets
Net foreign assets
In economics, the concept of net foreign assets relates to balance of payment identity.The net foreign asset position of a country is the value of the assets that country owns abroad, minus the value of the domestic assets owned by foreigners...
therefore is not deteriorating one to one with the current account deficits. The most recent experience has reversed this positive valuation effect, however, with the US net foreign asset position deteriorating by more than two trillion dollars in 2008. This was due primarily to the relative under-performance of domestic ownership of foreign assets (largely foreign equities) to foreign ownership of domestic assets (largely US treasuries and bonds).
See also
- Balance of paymentsBalance of paymentsBalance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
- Balance of tradeBalance of tradeThe balance of trade is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports...
- List of countries by current account balance
US specific:
- FRED (Federal Reserve Economic Data)
- U.S. public debt
External links
- Are Trade Deficits a Drag on U.S. Economic Growth?
- Where Do U.S. Dollars Go When the United States Runs a Trade Deficit? from Dollars & SenseDollars & SenseDollars & Sense is a magazine dedicated to providing left-wing perspectives on economics.Published six times a year since 1974, it is edited by a collective of economists, journalists, and activists committed to the ideals of social justice and economic democracy.It was initially sponsored by the...
magazine - CIA Fact Book of Account Rankings Worldwide
- Current Account Surplus Watch from New America FoundationNew America FoundationThe New America Foundation is a non-profit public policy institute and think tank with offices in Washington, D.C. and Sacramento, CA. It was founded in 1999 by Ted Halstead, Sherle Schwenninger, Michael Lind and Walter Russell Mead....