Does it matter if a country has a current account deficit?

Question 1

What is a current account deficit?

Answer 1

Value of outflow is greater than value of inflow

Question 2

What is the impact of a current account deficit on AD, real ouput and employment?

Answer 2

Loss of income and jobs from economy
Exports represent an injection into circular flow of income whereas imports represent a leakage
If value of imports is greater than value of exports there will be a net withdrawal from the circular flow
If an economy experiences an increase in the current account deficit then AD will fall

Question 3

What must countries be doing to run a current account deficit?

Answer 3

Selling assets foreigners such as land, property, shares or bonds
Attracting FDI from foreign companies
Attracting savings or hot money
Borrowing from abroad

Question 4

What is capital flight?

Answer 4

If countries have large deficits as a % of GDP, foreign leaders may lose confidence in ability of firms/banks in that country to repay loans
If lenders believe the borrower may default, they will recall loans and refuse to lend any more

Question 5

What might happen to countries if lenders believe the borrower may default and recall loans, refusing to lend any more?

Answer 5

This forces countries with a current account deficit to reduce imports
This results in lower standard of living in an economy as fewer foreign goods and services consumed

Question 6

How does the problem of a current account deficit depend on rate of economic growth?

Answer 6

If an economy is experiencing strong economic growth then GDP is rising
If current account deficit remains constant/rising at slower rate than economic growth then deficit will be falling as % of GDP

Question 7

How does the problem of a current account deficit depend if consumer goods/capital goods imported?

Answer 7

Invest in capital -> improves productive potential-> produce more->export more->beneficial for economy