Thursday, June 7, 2007

Reasons for Deterioration in Current Account Deficit

Examine reasons for a deterioration in the current account deficit.

A deterioration in the current account deficit implies a growing current account deficit: i.e. the value of imports increases at a faster rate than exports.

  1. Higher levels of economic growth. Higher growth implies higher levels of consumer spending. Therefore, this will lead to an increase in imports. This is a significant factor in the UK because we have a high marginal propensity to import. Basically this means that a rise in income causes a bigger % increase in spending on imports. (imports tend to be luxury goods.)
  2. Appreciation in the exchange rate. This causes exports to be more expensive and imports to be cheaper. Therefore quantity of exports fall. However, the effect depends on the elasticity of demand. If demand is inelastic, then more expensive exports will have little impact on reducing quantity.
  3. Loss of competitiveness. If exports become less competitive, due to lower productivity then demand for exports fall. This is likely to explain a long term deficit. It has occured to a large extent in the UK because of globalisation. E.g the UK has lost comparative advantage for the manufacture of many goods to Asian countries like China.

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