FREE ESSAY ON BALANCE OF PAYMENTS CURRENT ACCOUNT DEFICIT

BALANCE OF PAYMENTS CURRENT ACCOUNT DEFICIT

Essay Ken Hutchinson
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. 
-  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.