Describe only four (4) factors that create a current account deficit. Leave a space between each factor - Essay Example

Current Account deficit A record of the dealings made between a nation and the rest of the world during a particular time period is called the Balance of Payment (BoP) of that country for that year. The transaction includes both exports and imports of both visible and invisible goods and export and import of financial assets. The part of the Balance of payment, which calculates only the export, and import of goods and services excluding the financial transaction is called the Current Account. Therefore Current account equals exports minus import of goods and services and transfer of the country for a particular period of time (Hubbard and O’Brien, 36, G-1-G-2).

Deficit therefore implies that the value of the payment for the imports is greater than the receipt from the exports. The factors responsible for a current account deficit are:- Decline in domestic savings The domestic savings of a country is the path of increasing investments as in economics savings is considered to be identical to investments. If there is a continuous decline in the savings of a particular country then the scope of investment will causes an increase in the real interest rate of the country.

Increase in the domestic interest rate (real) in turn attracts more foreign investment in the country as the scope of return is expected to be high. With increasing foreign investment the demand of the home currency in the foreign exchange market also increases because of the need of   currency conversion. This creates an upward pressure on the value of the domestic currency in comparison to the foreign currencies. Moreover, with the decrease in savings as a percentage of the total Gross Domestic Product of the country, consumption increases.

Thus the demand for goods and services in the economy increases and if the domestic producers fail to meet up the increasing domestic demand of the country the import of the country increases resulting in a deficit in the current account. (Arnold). The current account deflation of US was mainly because of the decline in domestic savings of the country. Decline in the competitiveness A country may sometimes lack its competitiveness in terms of the price or the quality of the commodities that the country is exporting.

The country may charge high prices of the products because of any cost disadvantages. It may also supply poor quality products or the products, which has less demand in the market. This will create an adverse effect on the export of the country and the receipt of the country will consequently decrease resulting in a deficit in the current account. Current Account deficit has struck the UK economy because of decreasing competitiveness in the export-manufacturing sector of the economy. (“Factors, which cause a current account deficit in the Balance of payments”) High Exchange rate of a country Exchange of a country is expressed as the ratio of the value of the domestic currency to the value of the foreign currency.

If the currency value of any economy is high compared to the foreign currency then the exchange rate is expected to remain higher. The currency value my differ among countries due to difference in the inflation rates, difference in the rate of interest among the countries and also due to the difference in the amount of the public debt of each country. The terms of trade of a country and the nature of political and economical stability of a nation also determine the value of the currency of that particular economy.

Hence the export of that particular country will be more expensive compared to the import. This will reduce the volume of the export and hence increase the current account deficit (Investopedia). Recession Recession is also a factor that results in a trade deficit of a country. If the trading partners of a country face recession then the export of that country will deteriorate resulting in a deficit in the current account. Moreover recession in the domestic economy also increases the current account deficit through reducing output and productivity of the economy.

For instance, when the trading partners of an economy will face recession bottlenecks, it will affect the exports of the domestic nation as it did in UK (“Factors which cause a current account Deficit in the balance of Payments”) Conclusion From the above discussion one may conclude that all the four influencing factors such as competitiveness, recession, level of exchange rate and domestic savings will also be collectively indicated from the status of the Balance of Payment of a particular nation.

If there is a sudden fall in the same, one might seek to explore the influence parameters related with that nation. It therefore reflects the economic health of a country, which in turn is decided by the factors leading to the deficit. Works Cited Arnold, Bruce, “Causes and Consequences of Trade deficit”, Congressional Budget Office, March 2000, 21st January 2011 from “Factors which cause a current account deficit in the Balance of payments”, Economics.Help, n.d 21st January 2011, from Hubbard, Glenn and Anthony O’Brien, Microeconomics, Prentice Hall, 2005.

Investopedia, “Factors that influence Exchange rates”, 2010, 21st January 2011, from