THE EXTERNAL BALANCE
The internal & external balance are very important for all trading nations. Together, they make up the CURRENT ACCOUNT BALANCE.
Current Account: Part of the balance of payments account (record of financial dealings over a period of time between one country and all others) where payments for the purchase and sale of the goods & services are recorded.
Internal Balance: A situation in which aggregate demand = potential output.
External Balance: A situation for a country when the current account of the balance of payments is zero.
Imports of a country are a nations spending on foreign goods & services, and should be financed by exporting the country's own goods & services. If imports exceed exports, this must be financed by borrowing money or by running down savings held abroad.
CURRENT ACCOUNT DEFICIT: When imports exceed exports
Deficit problems: Foreign banks may refuse to lend any more money. This leads to a cut in domestic spending to curb the demand for imports. Side-effects of this include reduced economic growth and rising unemployment. This is known as a CREDIT CRUNCH'.
CURRENT ACCOUNT SURPLUS: When exports exceed imports.
Surplus problems: Firstly, surpluses reduce resources available for consumption. Without them, resources could be diverted to produce consumer goods or to increase exports. Secondly, a surplus reduces the amount of resources available for other countries. Therefore, for every surplus, there will be a deficit somewhere down the line. Countries with Current Account Deficits would require another country to reduce its surplus in order to remove its debt. This second example can sometimes cause political friction.
MOST COUNTRIES AIM FOR A CURRENT ACCOUNT BALANCE
The Current Account position of a country is an important indicator of its economic performance, and the external balance makes up a critical part of this.
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