TABLE OF CONTENT

Introduction        

Economic implications dealing trade deficits        2

Policies to reduce a current account deficit        5

Conclusion        8

Bibliography        

Balance of Payments

The international trade in goods and services between countries has increased significantly over the past fifty years. Specialization by each nation has made every country to engage in international trade and hence to maintain balance of payments.

        The balance of payments is a comprehensive systematic record of a country’s financial dealings with the rest of the world over a period of one year. This evaluates all payments among a country and its trading associates.

        The balance of payment account is divided into two sections, namely current and capital account. Thus the current account consisting the exports and imports of goods and services, net income flow, as well as transfer payments such as foreign aid grants. The current account balance is the accumulation of the balance of trade plus the interest, dividends, profits and transfers. On the other hand, capital account includes all the capital flows such as direct investment, financial investment, currency trading.

        At the end of the period the current account of the balance of payment can either have a trade deficit or a trade surplus in its accounts. A trade deficit would suggest that the exports are less than imports and a surplus would indicate that the country is exporting more than it imports.

The economic implications for countries dealing with trade deficits are that when a country’s imports are in excess of exports it would suggest that there is a negative demand for that country’s goods and services from abroad. Reduction in foreign demand would cause the aggregate demand to come down as it has the same implications on the economy as a reduction in one of the other three components of aggregate demand. So as a result, this will bring down the country’s output and thus the producers will only need fewer workers, causing a decrease in the level of workforce employed which would eventually create unemployment.

A deficit is likely to lead to a depreciation in the exchange rate, due to the fact that there is high demand for foreign currency and lesser demand for the domestic currency. This would make imports more expensive and hence could lead to imported inflation ultimately causing inflation in the economy.

For example, The UK’s current account deficit has grown from 29.2 billion in 2005 43.4 billion in 2006. (http://www.statistics.gov.uk/cci/nugget.asp?id=194) So as a result the economists expect the pound to weaken over the coming years.

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        As imports become expensive, it will reduce the people’s disposable income to buy imported goods and services. This will result in a drop of standard of living of the people as high prices reduce the variety of goods that are available to people to choose from.

Another unfounded worry about the trade deficit is that it will saddle future generations with an unsustainable “foreign debt”. When a country spends more than it earns from imports, it may have to finance it through foreign loans. This would increase foreign debt, which could be risky if there are high ...

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