Causes and consequences of current account imbalances

Overview

Recall questions on a sustainable balance of payments, how competitiveness, exchange rates and growth cause current account deficits, and the consequences and financing of imbalances.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What does a sustainable balance of payments position mean?

   Model answer

   A position in which any imbalance can be financed over the long term without forcing a sharp fall in the exchange rate, an unmanageable build-up of external debt or a squeeze on future living standards.

2. 2

   Why is a current account deficit not automatically a problem?

   Model answer

   A deficit financed by inward investment that raises future productive capacity can be sustained, and a small deficit relative to GDP is easily financed.

3. 3

   Explain how poor international competitiveness causes a current account deficit.

   Model answer

   If domestic costs, prices or product quality compare badly with rivals, export demand falls and domestic consumers switch to imports, so the deficit widens.

4. 4

   Explain how a strong exchange rate can cause a current account deficit.

   Model answer

   A stronger currency makes exports dearer to foreign buyers and imports cheaper at home, so export volumes fall while import volumes rise.

5. 5

   Explain how rapid domestic growth can worsen the current account.

   Model answer

   Rising domestic incomes pull in more imports, and if trading partners are growing more slowly, export demand does not rise to match.

6. 6

   How does deindustrialisation contribute to a persistent deficit on trade in goods?

   Model answer

   With a smaller manufacturing base the country produces fewer exportable goods and must import a larger share of the manufactures it consumes.

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