Essay, Research Paper: Current Account Deficit

Economics

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In
1994 the UK had a Balance of Payments current account deficit. Explain the
possible effects that this deficit might have upon the economy Discuss what, if
anything the UK Government could have done to reduce or eliminate this current
account deficit. The balance of payments is a record of one country's trade
dealings with the rest of the world. Any transaction involving UK and foreign
citizens is calculated in sterling (UK pounds). Dealings, which result in money
entering the country, are credit (plus) items while transactions, which lead to
money leaving the country, are debit (minus) items. The balance of payments can
be split up into two sections: 1. the current account which deal with
international trade in goods and services; 2. transactions in assets and
liabilities which deals with overseas flows of money from international
investments and loans; The current account consists of international dealings in
goods (visible trade) and services (invisible trade). Invisible trade includes
payments for overseas embassies and military bases: interest, profit and
dividends from overseas investment; earnings from tourism and transportation.
The cause of a deficit was that the UK imported more visible goods than it
exported and there was a net deficit on transfers, our service earnings plus
overseas incomes did not exceed our service payments plus investment income paid
abroad sufficiently to prevent the balance on current account being well in
deficit. The state of the trade balance is extremely important since changes in
imports and exports have a important bearing on the real economy and in
particular on output and employment. In the longer run, a persistent deficit, if
it cannot be offset by a surplus on invisibles, will have serious implications.
It will handicap the conduct of the macroeconomic policy. Its effect will be to
increase instability of exchange rates and/or interest rates as the UK becomes
dependent on inflows of hot money to finance the deficit. Higher interest rates
are also likely to cause a reduction in real investment and therefore in
economic growth. The current account deficit might also be financed by increased
sales of assets to overseas firms and residents, which in the long run, will
lead to an increased outflow of interest, profits and dividends. The balance of
payments always balances because of official financing. However, a balance of
payments deficit means a persistent and large negative balance for official
financing. This can be the result of excessive purchases of foreign goods and
services or excessive UK investment overseas. In the short term, a balance of
payments deficit can be corrected by:  continued borrowing of foreign
currency;  increasing interest rates to attract overseas investors;
 imposing exchange controls;  Imposing tariffs and import
quotas. In the long run, the government can correct a balance of payments
deficit by reducing demand in the economy for all goods including imports.
Reducing UK inflation rates or encouraging a sterling depreciation will also
help. The correct measures to remedy a deficit will depend upon its cause and
also upon the exchange rate regime. A short-term deficit might be dealt with by
running down reserves or by borrowing. Another short-term measure might be to
raise interest rates to encourage the inflow money. When there is a more
fundamental payments deficit, other methods will have to be taken. The following
show ways in which the government can tackle the problem of a deficit in the
Current Accounts. Deflation is where the demand for imports are restrained by
restricting the total level of demand in the country through fiscal and monetary
polices Protection is where the country cuts all trade with the outside world by
cutting off all imports and therefore protecting the home market from foreign
competition Devaluation is where a fixed exchange rate drops the external price
of its currency, as the UK did in 1967 when the rate changed from 1=$2.80 to
1=2.40, this is referred to as a devaluation which means exports will now
appear cheaper to foreigners while imports will seem more expensive to domestic
customers.

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