Current Account | A-Level Economics Notes

These revision notes cover everything you need to know about the Current Account for A-Level Economics. They're designed for students studying AQA A-Level Economics, Edexcel A-Level Economics, and Edexcel International A-Level Economics. Written by Jaisul Naik, UCL Economics graduate and A-Level Economics tutor since 2017.

What are the four components of the current account?

The current account is part of the balance of payments. It is made up of:

1. trade in goods
2. trade in services
3. primary income - income from work, investments, dividends
4. secondary income - gifts, aid, remittances

What is a current account deficit?

A current account deficit is when the value of imports is greater than the value of exports.

What is a current account surplus?

A current account surplus is when the value of exports is greater than the value of imports.

What are three causes of a current account deficit?

1. strong exchange rate
2. poor competitiveness (structural)
3. high economic growth (cyclical)

What is the impact of a current account deficit on macroeconomic performance?

Decrease in economic growth

1. a current account deficit means that the value of imports are higher than the value of exports
2. since AD = C+I+G+(X-M), aggregate demand would shift to the left.
3. this means that the economy would see a fall in real gdp since imports are leakages and exports are injections in the circular flow.
4. also, as a result of a lower demand for exports, there would be a fall in the derived demand for labour.

Sign of economic growth

1. A current account deficit is a common trade-off with economic growth 
2. Economic growth is associated with high levels of employment and incomes
3. This leads to an increase in demand for luxury goods like cars, which are usually imported. 
4. It is also associated with higher levels of inflation.
5. This makes foreign goods more competitive relative to UK goods.
6. In countries like the UK, net exports (X-M) makes up a small proportion of aggregate demand, whereas consumer spending makes up roughly 60% of AD. 
7. Therefore a current account deficit could be a sign of a strong economy, but this is not likely to be a major concern in the UK.

Sign of poor competitiveness

1. A persistent current account deficit could be a sign of poor competitiveness.
2. This is when a country cannot produce goods and services at a lower price than other countries.
3. This can lead to further problems such as structural unemployment which occurs when an industry declines.
4. For example, the steel industry has declined as it is cheaper to import steel from China.
5. This also makes the UK more vulnerable to economic shocks.
6. For example, if there is a supply-side shock in China, this increases costs of production for UK firms, which causes cost-push inflation.

What is the impact of a current account surplus on macroeconomic performance?

Economic growth

1. X-M is a component of aggregate demand.
2. An increase in net exports would lead to an increase in aggregate demand.
3. This causes economic growth to increase.
4. This can lead to a fall in unemployment due to more derived demand for labour

How does a current account deficit automatically correct itself?

1. A high level of imports and a low level of exports leads to an increase in the supply of pounds and a decrease in the demand for pounds.
2. This causes a currency depreciation.
3. This makes exports cheaper and imports more expensive.
4. This should lead to an improvement in the current account.

How does a current account surplus automatically correct itself?

1. A high level of exports and a low level of imports leads to a decrease in the supply of pounds and an increase in the demand for pounds.
2. This causes a currency appreciation.
3. This makes exports more expensive and imports cheaper.
4. This should lead to a natural reduction in the current account surplus.

What are five ways to reduce a current account deficit?

Currency devaluation (expenditure-switching)

1. a country with a fixed exchange rate can cause a currency devaluation by selling domestic currency reserves and buying foreign currency reserves.
2. for example, China could sell more yuan and buy more dollars.
3. this causes an increase in the supply of yuan and an increase in demand for dollars.
4. this causes the value of the yuan to fall relative to the dollar, making Chinese exports cheaper and American imports more expensive.

Evaluation: Marshall-Lerner Condition & J-Curve

Currency depreciation (expenditure-switching)

1. the central bank can cause a forced depreciation of the currency.
2. by decreasing interest rates, the reward for saving falls.
3. this causes a net outflow of hot money as people aim to take advantage of higher interest rates elsewhere.
4. this causes a decrease in the demand for the pound and an increase in the supply of the pound, causing a currency depreciation.
5. this makes exports cheaper and imports more expensive, which should lead to an improvement in the current account.

Evaluation: Marshall-Lerner Condition & J-Curve

Protectionism (expenditure-switching)

1. a tariff is a tax on imports.
2. as a tariff causes prices to increase, UK firms are able to compete against foreign firms to a greater degree.
3. this allows consumers to reduce spending on imports and increase spending on goods and services produced domestically.
4. additionally, tariffs generate tax revenue, which can be used to subsidise UK businesses which can lead to an increase in competitiveness, and therefore an increase in exports.
5. this should lead to an improvement in the current account deficit

Evaluation: retaliation/trade-wars

Supply-side policies (expenditure-switching)

1. supply side policies such as lower corporation taxes allow firms to retain more profits.
2. this allows firms to increase investment in capital, which can lead to an increase in productivity.
3. this can lead to a right shift in the long-run aggregate supply curve, which leads to a lower price level.
4. this makes uk goods and services more competitive, making exports more attractive.

Evaluation: opportunity cost and time-lags

Contractionary fiscal policy (expenditure-reducing)

1. contractionary fiscal policies such as higher income taxes reduce disposable incomes.
2. consumers with a high marginal propensity to import would now import less as their incomes are lower.
3. additionally, higher income taxes causes a fall in consumer spending and a fall in aggregate demand.
4. this causes the price level to fall, making UK exports more competitive.

Evaluation: trade-offs e.g. slower economic growth and higher unemployment

Summary questions

1. What are the four components of the current account?
2. What is a current account deficit?
3. What is a current account surplus?
4. What are three causes of a current account deficit?
5. What is the impact of a current account deficit on macroeconomic performance?
   1. economic growth slowing down
   2. sign of economic growth
   3. sign of poor competitiveness
6. What is the impact of a current account surplus on macroeconomic performance?
7. How does a current account deficit automatically correct itself?
8. How does a current account surplus automatically correct itself?
9. What are five ways to reduce a current account deficit?

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