UK Current Account Deficit
Source: ONS retrieved Dec 14th 2009
The Current account deficit measures the balance of trade in
- Investment incomes
- Current transfers
Why Current Account Deficit Should HaveDepreciation in Sterling. Since 2007, the value of Sterling has fallen over 20%. This should make British exports more competitive and imports more expensive. This should increase demand for our exports and reduce domestic consumption on imports. This should (assuming demand is relatively elastic) improve the current account deficit.
Deep Recession. Current account deficits tend to be cyclical. When consumer spending falls in a recession, it means we will buy less imported goods. UK consumer spending has fallen in 2009, due to higher unemployment and a rise in the savings ratio. In theory, this reduction in spending should reduce imports and improve the current account deficit.
Why Deficit hasn't FallenTerms of Trade hasn't changed. As we looked at here: Terms of Trade Effect The depreciation has not led to a change in the terms of trade. To summarise
- Import prices have increased (as expected)
- But, export prices have also increased.
Time Lags. The effect of a depreciation in the exchange rate often takes a long time to have an effect. Firms often have fixed contracts so it takes time for changed exchange rate to be reflected in prices. In the short term demand is often inelastic, but, over time becomes more elastic (Students of Economics may remember the J Curve Effect)
Slow Growth in other Countries. Although the UK consumer has been effected by the recession, so have our main competitors.
Outlook for Long RunIn the long run, I would expect an improvement in the current account.
- Higher profit margins in exports should encourage more firms to increase supply
- More expensive imports should over time switch demand to domestic consumption.
- The UK recession seems to be longer lasting than our European competitors.