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Current Account Balance Definition
Current account balance refers to the country’s balance of trade and reflects the level of imports and exports of goods and services of a nation and whether there is an equilibrium between the two. A current account is also concerned with measuring the movement of money in the international arena.
A Little More on What is a Current Account Balance
The current account is termed to be well balanced if those living in the country have enough money to engage in buying activities in the country. By those, we mean all businesses, government, and the people. The source of such capital consists of all the savings and income. Purchases entail all that is spent by final consumers, government expenditure on infrastructure and for the growth of businesses
One major objective of most countries is to engage in more exports that they import so that they can accumulate a lot of money. This is commonly referred to as surplus in trading to mean the country will earn more money. In some cases, governments, individuals and businesses may experience trade deficit when they import more products as opposed to those that they export. The implication of this is that they receive less money from these foreign trade partners and give them more money.
The current account forms part and parcel of the nation’s balance of payments. The other two components are the financial accounts and capital accounts.
The Four Current Account Components
The Bureau of Economic Analysis classifies the current account into four parts namely net income, asset income, trade and direct transfers of capital.
Trade: Trading in various products and commodities are the major aspects of the current account. As a result, the trade deficit has the capacity to result in a current account deficit. This is true due to the fact that a deficit in products and services has the capacity to offset surplus in direct transfers, asset income and net income.
Net Income: This is the money received by those residing in a country less the money paid to foreigners. This money is mostly gotten from two origins. The first income emanates from foreign assets belonging to the businesses and the residents in a country. These entail dividends and interests earned from foreign investments. The second origin is from citizens working abroad
Money paid to foreigners is usually the same as the first level of payment being dividends and interests earned by foreign internationals who have assets in the nation. Another category is the wages earned by foreigners who are employees in that nation.
The net income is said to be positive if the money earned by the country’s businesses, government and individuals from foreign entities exceeds the amount of money paid to them. On the other hand, a deficit is brought about if the sum received is less than the amount paid out.
Direct Transfers: This is composed of all the contributions from foreign workers to their home nation, for instance, Mexico earns up to the tune 25 billion dollars from overseas. As far as there are no specific figures, there is a possibility that most of the amount comes from immigrants staying in the United States of America. The current head of state Mr. Donald Trump during his campaigns had alleged that he was going to cancel those payments in case Mexico did not remit the money for the construction of the border wall that he had proposed. He was going to achieve this by the use of the Patriot Act to do away with the payments in the Western Union. This was going to decline Mexico’s economic output by 1% and double its current account deficit of 29$ billion.
Direct Transfers entails foreign direct investments too. An example is the 22 billion dollars that the United States channels towards annual foreign aid. This in result increases America’s current account deficit from the present $502 billion which is the largest globally.
The third avenue of direct transfer is foreign direct investments. This occurs when businesses of a country of or residents open investment in other countries. For it to qualify as a Foreign Direct Investment, it must contain at least 10 percent of the foreign firm’s capital.
The fourth means of direct transfer are loans given to foreigners by banks.
Asset Income: This consists of growth or decline in bank deposits, government and central bank reserves, real estate and securities. For instance, if the assets of a nation perform well, the earnings from the assets will be more. Normally, the assets belonging to the United States foreigners get deducted from the asset earning. They entail the following:
- A nation’s obligation to foreigners like deposits belonging to overseas residents at the banks in the country.
- Loans given to local banks by overseas banks.
- Overseas private buying of a nation’s government bonds, like the U.S. Treasury securities.
- Disposing of such securities like bonds and stocks through selling to foreigners by the country.
- A foreign direct investment like equities, debt and reinvested earnings.
- Debts belonging to foreigners.
- Assets retained by governments abroad.
- Net shipments of the country’s currency to foreign governments
References for Current Account Balance
Academic Research on Current Account Balance
- The current account in the macroeconomic adjustment process, Sachs, J. D. (1981). This article is concerned with the analysis of the current account balance in the macroeconomic processes. Two findings are established the first one being that the current account of an account relies on economic trends established in the economy while the second finding states that any interference in the economy permanently influences the whole future situation of the economy in relation to the international debt.
- Exchange rates and the current account, Dornbusch, R., & Fischer, S. (1980). The American Economic Review, 70(5), 960-971. The author in this article talks about how current account relates to different exchange rates and how they impact on one another in the financial environment.
- Budget deficits and the current account balance: New evidence from panel data, Mohammadi, H. (2004). Journal of Economics and Finance, 28(1), 39-45. The article tries to investigate the models of the macroeconomy by finding out how current account balance is influenced by fiscal policy. The study finds out that a decline in public savings negatively impacts on the current account balance. It also finds out that a bond-financed alternative mode of government expenditure has a bad effect on the current account balance compared to a tax-financed method.
- The global saving glut and the US current account deficit, Bernanke, B. (2005). (No. 77). Board of Governors of the Federal Reserve System (US). The paper is concerned with the United State’s large and growing current account deficit and how they influence various economic policies in the US. The author is also concerned with how saving glut has discouraged credit flow in developing nations. It goes ahead to state how this phenomenon has transformed these nations from borrowers in the international arena to be lenders.
- Comovements in budget deficits, money, interest rates, exchange rates and the current account balance: some empirical evidence, Ibrahim, S. B., &Kumah, F. Y. (1996). Applied Economics, 28(1), 117-130. The author in this article is determined with finding out how macroeconomic variables relate in an open economy, and how budget deficit is ignored in that analysis. The author in this paper, therefore, tries to correct the assumption by putting into consideration budget deficits in the behaviors of macroeconomic variables such as interest rates, budget deficits, current account balance and exchange rates by use of VAR method. The outcomes show that monetary innovations, unlike fiscal innovation, explain a lot of variance in the level of interest rates in the financial field
- The relationship of the current account balance and the budget balance, Winner, L. E. (1993). The American Economist, 37(2), 78-84. This article believes that there is a positive correlation between the current account balance, the traditional theory, and the budget balance. This is not however true in the Australian data which argues that economic movements are better explained by the Ricardian Equivalence Theorem.
- Effects of budget deficits on the current account balance in Nigeria: A simulation exercise, Egwaikhide, F. O. (1997). This article dwells on the impacts that budget deficit has on the current account balance of Nigeria between the period of 1973 to 1993. There was a deficit in the current account balance manifesting that the two variables highly correlate. The survey further revealed that the policy of budget in Nigeria affects its current account balance. In addition to this, the author claims that increased expenditure and budget deficit leads to the decline of current account whether the source of fund is foreign borrowing or bank credit.
- The Current–account Balance and the Dollar: 1977-78 and 1983-84, Golub, S. S. (1986). This section investigates how current-account balance impacts on the Dollar in terms of its value. It dwells on what happens to the dollar rates in cases of both deficit and a surplus.
- Current–Account sustainability in transition economies, Roubini, N., &Wachtel, P. (1999). In Balance of Payments, Exchange Rates, and Competitiveness in Transition Economies (pp. 19-93). Springer, Boston, MA. The article is concerned with how growing unsustainable current-account imbalance relates to a currency crisis. The peso crisis of Mexico in 1994 and the currency crisis of 1997 in various Asian nations (Malaysia, Thailand, and the Philippines) were brought about by the unsustainable current-account imbalances. The Mexican crisis encouraged the IMF to come up with ways of recognizing current account imbalances in advance in most countries. A number of European countries with weak financial systems embraced semi-fixed regimes of exchange rates to control inflation, leading to an appreciation in their currencies. Finally, the author claims that currency turmoil in South Asia and Mexico were as a result of a mixture of real appreciation, fixed-rate regimes, worsening of current-account, and short term accumulation of foreign debt amongst others.
- Response of financial markets to announcements of the Australian current account balance, Singh, R. A. (1995). Accounting & Finance, 35(2), 155-174. The author in this section talks about how the financial markets responded to the announcements of the current account balance. Different financial markets react differently to the current account balance.
- The real exchange rate and the current account balance in Japan, Song, C. Y. (1997). Journal of the Japanese and International Economies, 11(2), 143-184. The paper focuses on the investigation of how the current account balance in Japan relates to the real exchange rate. The survey establishes that long- term real rate of interests are the major economic variables which influence both the current account balance and real exchange rates in Japan. This aspect greatly accounts for the behavior of current accounts in Japan.