Current Account of the Balance of Payments
International Trade & Globalisation · 2 question types
Exam Frequency Analysis
Past paper frequency (2018 to 2024)
This topic accounts for approximately 5% of your exam marks.
New emphasis in the 2027 syllabus; the structure of the current account and the causes, consequences and correction of deficits and surpluses are examined directly. Guidance based on specimen materials.
A deficit or surplus affects GDP, employment, inflation and the exchange rate, and neither is automatically good or bad.
Consequences of a deficit
- GDP and employment. Spending on imports rather than home-produced goods means lower demand for domestic output, which can reduce GDP and raise unemployment.
- The exchange rate. A persistent deficit raises the supply of the currency on the FX market (residents selling it to buy imports), which tends to cause the currency to depreciate.
- Inflation. The effect works both ways. That same leakage of spending abroad takes demand out of the economy, easing demand-pull pressure on prices. But the depreciation a persistent deficit tends to cause makes imported food, fuel and raw materials dearer, adding to cost-push (imported) inflation. Which effect dominates depends on how far the currency falls and how import-dependent the economy is.
- Financing the gap. The country must cover the deficit by borrowing from abroad or selling assets, building up debt and interest payments. A large, prolonged deficit can become hard to finance.
A deficit is not always harmful: if it arises because firms are importing capital goods that will raise future output, it can support long-run growth.
Consequences of a surplus
- GDP and employment. Strong net exports raise demand for domestic output, supporting GDP and employment.
- Inflation and the exchange rate. Strong export demand can add to demand-pull inflation, and the surplus tends to push the currency up, which can later reduce competitiveness.
- Living standards and trade relations. A surplus means more goods leave the country than come in, and those exports could have been consumed at home; trading partners running matching deficits may also complain or retaliate.
Discuss whether a current-account surplus raises living standards (8 marks)
What comes up: an 8-mark "Discuss whether or not an increase in a current-account surplus will raise living standards." Both sides plus a judgement are required.
Write: Why it might: a larger surplus raises demand for exports and so raises employment (1); higher employment can raise wages (1), letting households consume more goods and services (1); higher incomes raise tax revenue, so the government can spend more on education and healthcare (1). Why it might not: a surplus means more goods and services leave the country (1) when they could have been consumed at home (1); resources may be depleted, reducing future living standards (1); the extra demand may cause inflation (1) and some people's incomes may not keep up with rising prices (1). Judgement: state whether the surplus is likely to raise living standards and why, for example that it helps if the higher incomes are widely shared and inflation is kept under control.
Watch out: a one-sided answer is capped below the top band. Develop each chain, and remember that exporting more is not the same as consuming more at home.