Explain the various factors that would lead to an increase in the size of the Deficit on the Current Account of the Balance of Payments.
Louise Carvey
Explain the various factors that would lead to an increase in the size of the Deficit on the Current Account of the Balance of Payments
The current Account is a key indictor for the British economy. It is the sum of four separate trade balances between the UK and the Rest of the World. The Current Account records the exports and imports of both visible invisible items. Therefore a deficit on the Current Account occurs when we was a country are either importing too many goods and services from abroad, or are not exporting enough, usually it is a mixture of both.
UK consumers have a high income elasticity of demand therefore the demand for imported goods increases, also as people feel more wealthy they are more likely to spend on luxury goods such as holidays abroad. These holidays are also made to look more attractive with the advertising campaigns by companies. Companies that rely on imported raw materials and components in order to increase their productive output add to the size of the current account deficit.
As UK consumers have a high-income elasticity of demand and the UK producers have insufficient capacity to meet the demand from consumers then imports will come in to satisfy the excess demand. If the pound is strong in the economy then foreign imports will be cheaper therefore will be more attractive to the UK consumers as they are more competitive within the home market because companies are unable to expand in the short run to meet the increases in demand for certain products. If the pound is strong then the price of UK exports will be more expensive in foreign countries, the UK goods will therefore be less competitive within the market and so the deficit on the current account will increase. If consumers are spending more on imported goods it is leading to higher levels of unemployment in the UK this leads to lower economics growth as more people are unemployed. These factors have a large impact on the current account deficit, a way in which to solve this problem would be to depreciate the exchange rate. Depreciation in the exchange rate would provide a competitive boost to UK producers and might lead to an improvement in the balance of payments. However, a low exchange rate would also lead to an increase in the costs of imported goods and services risking higher “cost-push” inflation. However depreciating the exchange rate in the short run would not decrease the deficit on the Current Account in fact it would do the opposite this is because companies may be locked into contracts with companies over seas and also it takes time for people to change their spending patterns therefore the deficit would increase before it decreased, this is known as the J-curve effect. Exports can also be increased if our domestic industries increase their competitiveness in other ways. Higher productivity helps to reduce unit costs; greater investment in new capital and research and development can lead to a faster pace of innovation and the development of new products in export sectors. Non-price competitiveness can also be improved by better design, after sales service, guaranteed delivery dates and more effective marketing.
