Overview of Current Account Balance
The current account is the difference between exports of goods and services and imports of goods and services. If we denote the current account balance by CA, we can express this definition in symbol as CA = EX – IM
The current account balance is one of two major measures of the nature of a country's foreign trade (the other being the net capital outflow. A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period. The balance of trade is the difference between a nation's exports of goods and services and its imports of goods and services, if all financial transfers, investments and other components are ignored. A Nation is said to have a trade deficit if it is importing more than it exports. A positive net sale abroad generally contributes to a current account surplus; a negative net sale abroad generally contributes to a current account deficit. Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports. The net factor income or income account, a sub-account of the current account, is usually presented under the headings income payments as outflows, and income receipts as inflows. Income refers not only to the money received from investments made abroad but also to the money sent by individuals working abroad, known as remittances, to their families back home. If the income account is negative, the country is paying more than it is taking in interest, dividends, etc. The various subcategories in the income account are linked to specific respective subcategories in the capital account, as income is often composed of factor payments from the ownership of capital (assets) or the negative capital (debts) abroad. From the capital account, economists and central banks determine implied rates of return on the different types of capital. In the traditional accounting of balance of payments, the current account equals the change in net foreign assets. A current account deficit implies a paralleled reduction of the net foreign assets. Current account = changes in net foreign assets
1.2 Components related with current account balance:
In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).
(a) National Income and Domestic resident Spending:
Current account is defined as the difference between exports and imports. The current balance is also equal to the difference between national income and domestic residents’ spending. As per national income identity
CA = Y – (C + I + G)
Y= National Income
C + I + G = Domestic resident Spending
It is only by borrowing abroad that a country can have a current account deficit and use more output than it is currently producing. If it uses less than its output, it has a current account surplus and is lending the surplus to foreigners.
(b) Savings- investment and the Current account:
National savings is the portion of output, Y is not devoted to households consumption, C, or government purchase G. In a closed economy national savings always equals investment. If S stands for national savings as per national income identity –
S = Y – C – G
Since the closed economy GNP identity Y = C + I + G may also be written as
I = Y – C – G
Or, S = I
As national savings must equal investment in closed...