International Trade and Globalisation: Current Account of the Balance of Payments

This section explores the current account component of the balance of payments and the policies governments can use to achieve balance of payments stability. We will examine the range of available policies and their effectiveness.

Understanding the Balance of Payments

The Balance of Payments (BoP) is a record of all economic transactions between a country and the rest of the world over a specific period. It is divided into two main accounts: the Current Account and the Capital and Financial Account.

The Current Account

The Current Account reflects the flow of goods, services, income, and current transfers between a country and the rest of the world. It is a key indicator of a country's economic health and competitiveness.

The Current Account is further divided into:

• Balance of Trade (BoT): The difference between the value of a country's exports and imports of goods and services.
• Primary Income: Income earned from investments (e.g., profits, wages, dividends) and income paid to other countries.
• Secondary Income: Current transfers such as foreign aid, remittances, and pensions.

The Current Account Deficit and Surplus

A Current Account Deficit occurs when a country's imports exceed its exports. This means the country is buying more from the rest of the world than it is selling.

A Current Account Surplus occurs when a country's exports exceed its imports. This indicates the country is selling more to the rest of the world than it is buying.

Causes of Current Account Deficits

Several factors can contribute to a current account deficit:

• High Demand for a Country's Goods and Services: If other countries have a strong demand for a nation's products, it can lead to increased exports and a current account surplus. Conversely, a decline in global demand can cause a deficit.
• High Levels of Consumption: If a country's consumers tend to spend more than they produce domestically, it can lead to increased imports and a current account deficit.
• Strong Currency: A strong domestic currency makes imports cheaper and exports more expensive, potentially leading to a current account deficit.
• Low Productivity: If a country's industries are less productive than those in other countries, its exports may be less competitive.
• High Government Spending: Increased government expenditure can lead to higher imports.

Policies to Achieve Balance of Payments Stability

Governments have a range of policies available to influence the current account and achieve balance of payments stability. These policies can be broadly categorized into monetary and fiscal policies, and exchange rate policies.

Monetary Policy

Interest Rate Adjustments: Central banks can raise interest rates to attract foreign capital, increasing the demand for the domestic currency and strengthening its value. This can help reduce a current account deficit by making imports cheaper and exports more expensive. Conversely, lowering interest rates can weaken the currency, potentially worsening a deficit.

Policy	Effect on Exchange Rate	Effect on Current Account
Raise Interest Rates	Strengthens Currency	Reduces Current Account Deficit
Lower Interest Rates	Weakens Currency	Worsens Current Account Deficit

Fiscal Policy

Government Spending and Taxation: Increasing government spending can boost domestic demand and potentially increase imports, worsening the current account. Conversely, reducing government spending or increasing taxes can decrease domestic demand and imports, improving the current account.

Exchange Rate Policy

Fixed Exchange Rate: A fixed exchange rate involves the government or central bank pegging the value of its currency to another currency or a basket of currencies. This can provide stability but limits the ability to adjust to economic shocks.

Floating Exchange Rate: A floating exchange rate allows the value of the currency to fluctuate based on market forces of supply and demand. This provides flexibility but can lead to volatility.

Managed Float: A managed float is a hybrid approach where the exchange rate is primarily determined by market forces, but the central bank intervenes to smooth out excessive volatility.

Effectiveness of Policies

The effectiveness of these policies can vary depending on the specific circumstances of the country and the global economic environment.

• Interest Rate Policy: Generally effective in the short run, but can have lagged effects and may not be effective if other countries are also lowering interest rates.
• Fiscal Policy: Can be effective but may be politically difficult to implement. Its impact can also be delayed.
• Exchange Rate Policy: A fixed exchange rate can provide stability but may not address underlying economic imbalances. A floating exchange rate can be effective but may lead to volatility. Managed floats can offer a compromise.

Other Policies

Besides monetary, fiscal, and exchange rate policies, other measures can be taken to improve the current account:

• Promoting Exports: Governments can provide incentives for exporters, such as export subsidies and marketing support.
• Reducing Imports: Policies such as tariffs and quotas can be used to reduce imports, but these can lead to trade disputes.
• Improving Productivity: Investing in education, technology, and infrastructure can improve productivity and competitiveness, leading to increased exports.

Conclusion

Achieving balance of payments stability is a complex challenge that requires a combination of policies. The most effective approach will depend on the specific circumstances of the country and the global economic environment. Governments must carefully consider the potential trade-offs and long-term consequences of their policy choices.