Can a Country Have a Current Account Deficit and Surplus?

Question:

Is it possible for a country to have a current account deficit at the same time it has a surplus in its balance of payments? Explain your answer using hypothetical figures for the current and non-reserve financial accounts. Be sure to discuss the possible implications for official international reserve flows.

The U.S. government began running budget surpluses during the Clinton administration (which have of course become large deficits since that time). Japanese officials maintained that a key step for reducing the U.S. current account deficits was not that foreign markets should become more open to U.S. exports but, rather, that the U.S. government should have reduced its budget deficits at that time. Was there validity to that point? If so, why? If not, why not?

Answer Explanation:

Yes, a country can have a current account deficit while simultaneously having a surplus in its overall balance of payments. This situation can occur due to differences in the flows recorded in the current account and those recorded in the financial account, particularly the non-reserve financial account.

Understanding the Current Account and Balance of Payments

Current Account Deficit: The current account records a country’s transactions involving goods, services, investment incomes, and current transfers with the rest of the world. A deficit in the current account means that the value of imports and payments abroad exceeds the value of exports and receipts from abroad.

Balance of Payments (BOP): The balance of payments includes all financial transactions made between a country and the rest of the world, consisting of the current account, the capital account, and the financial account. If there is a surplus in the balance of payments, it indicates that inflows of funds (from trade, investments, etc.) are greater than outflows.

How Can a Country Have a Current Account Deficit and BOP Surplus?

Surplus in the Financial Account: The financial account records net changes in ownership of international financial assets. A surplus in the financial account (including direct investments, portfolio investments, and other investments) can offset a current account deficit.

Hypothetical Example:

Suppose a country has a current account deficit of $100 billion, which implies it is importing more goods and services than it exports.
Simultaneously, the country has a non-reserve financial account surplus of $150 billion, indicating it is attracting more investments and financial inflows than it is investing abroad.

The overall balance of payments would then show a surplus of $50 billion ($150 billion surplus in the financial account – $100 billion deficit in the current account).

Official International Reserve Flows:

When there is a surplus in the balance of payments, the central bank might decide to increase its reserves. This increase in reserves can be used to stabilize the country’s currency or manage exchange rates.

Conversely, a deficit would typically result in a decrease in reserves as the central bank sells reserves to cover the deficit.

Implications for the U.S. Current Account Deficit and Budget Deficits:

Japanese officials argued that reducing the U.S. government’s budget deficits would help address the U.S. current account deficits. This perspective is based on the idea that:

Twin Deficits Hypothesis: There is often a connection between a country’s budget deficit and its current account deficit. A budget deficit can lead to higher interest rates to attract foreign capital, which in turn appreciates the currency, making exports more expensive and imports cheaper, thus worsening the current account deficit.

Reducing Budget Deficits: By reducing its budget deficits, the U.S. government could lower domestic demand (including demand for imports) and reduce upward pressure on interest rates. This would potentially decrease the current account deficit by making exports more competitive and reducing the attractiveness of imports.

Validity of the Point:

Yes, the Japanese officials’ point is valid. A lower budget deficit could reduce the need for foreign capital inflows, lower interest rates, and help rebalance the current account. Reducing the budget deficit could help manage both inflation and exchange rates, indirectly supporting a lower current account deficit.

Yes, a country can have a current account deficit while maintaining an overall balance of payments surplus due to offsetting financial account surpluses. Addressing budget deficits could be a valid strategy for reducing current account deficits, as argued by Japanese officials because it impacts demand, investment, and foreign exchange dynamics.