In1994 the UK had a Balance of Payments current account deficit. Explain thepossible effects that this deficit might have upon the economy Discuss what, ifanything the UK Government could have done to reduce or eliminate this currentaccount deficit. The balance of payments is a record of one country’s tradedealings with the rest of the world.
Any transaction involving UK and foreigncitizens is calculated in sterling (UK pounds). Dealings, which result in moneyentering the country, are credit (plus) items while transactions, which lead tomoney leaving the country, are debit (minus) items. The balance of payments canbe split up into two sections: 1. the current account which deal withinternational trade in goods and services; 2. transactions in assets andliabilities which deals with overseas flows of money from internationalinvestments and loans; The current account consists of international dealings ingoods (visible trade) and services (invisible trade).
Invisible trade includespayments for overseas embassies and military bases: interest, profit anddividends from overseas investment; earnings from tourism and transportation. The cause of a deficit was that the UK imported more visible goods than itexported and there was a net deficit on transfers, our service earnings plusoverseas incomes did not exceed our service payments plus investment income paidabroad sufficiently to prevent the balance on current account being well indeficit. The state of the trade balance is extremely important since changes inimports and exports have a important bearing on the real economy and inparticular on output and employment. In the longer run, a persistent deficit, ifit cannot be offset by a surplus on invisibles, will have serious implications.
It will handicap the conduct of the macroeconomic policy. Its effect will be toincrease instability of exchange rates and/or interest rates as the UK becomesdependent on inflows of hot money to finance the deficit. Higher interest ratesare also likely to cause a reduction in real investment and therefore ineconomic growth. The current account deficit might also be financed by increasedsales of assets to overseas firms and residents, which in the long run, willlead to an increased outflow of interest, profits and dividends. The balance ofpayments always balances because of official financing. However, a balance ofpayments deficit means a persistent and large negative balance for officialfinancing.
This can be the result of excessive purchases of foreign goods andservices or excessive UK investment overseas. In the short term, a balance ofpayments deficit can be corrected by: ? continued borrowing of foreigncurrency; ? increasing interest rates to attract overseas investors;? imposing exchange controls; ? Imposing tariffs and importquotas. In the long run, the government can correct a balance of paymentsdeficit by reducing demand in the economy for all goods including imports. Reducing UK inflation rates or encouraging a sterling depreciation will alsohelp. The correct measures to remedy a deficit will depend upon its cause andalso upon the exchange rate regime.
A short-term deficit might be dealt with byrunning down reserves or by borrowing. Another short-term measure might be toraise interest rates to encourage the inflow money. When there is a morefundamental payments deficit, other methods will have to be taken. The followingshow ways in which the government can tackle the problem of a deficit in theCurrent Accounts.
Deflation is where the demand for imports are restrained byrestricting the total level of demand in the country through fiscal and monetarypolices Protection is where the country cuts all trade with the outside world bycutting off all imports and therefore protecting the home market from foreigncompetition Devaluation is where a fixed exchange rate drops the external priceof its currency, as the UK did in 1967 when the rate changed from ?1=$2. 80 to?1=?2. 40, this is referred to as a devaluation which means exports will nowappear cheaper to foreigners while imports will seem more expensive to domesticcustomers.