Current Account Essay

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The current  account measures transactions  in goods, services,  and  income,  as  well as  current   transfers between  residents  and  nonresidents  of  a  country. As such,  the  current  account  records  the  value of real resource  transactions  (i.e., exchanges  involving goods, services, and  income)  and  current  transfers (i.e., unilateral transfers such as food donations)  in a specific time period between a country and the rest of the world. The balance on the current account and the size of the current  account relative to gross domestic product  are important indicators  of a country’s integration and openness to the rest of the world.

The value of transactions  recorded  in the current account  of a country  is estimated  through  periodic surveys of economic exchanges between its residents and nonresidents. In the current account, each transaction is recorded  either as a credit or debit entry. A transaction  that is a source of foreign exchange leads to a credit entry; a transaction  that is a use of foreign exchange  generates  a debit  entry.  Thus, exports  of merchandise  goods are recorded  as credit  whereas imports are recorded as debit.

The current account is said to be in deficit when the value of real resources and current  transfers acquired from the rest of the world exceeds the value of real resources and current transfers provided to the rest of the world. A surplus in the current  account indicates that  the opposite  is true: real resources  and current transfers to the rest of the world have a greater economic value than those from the rest of the world. Furthermore,  the balance on the current  account shows the relationship  of national  expenditure  to national income.  A current  account  deficit  indicates  that  a country  spends more than  it produces  (its income); the difference between what it spends and produces is imported from the rest of the world.

The current  account  is a primary component of a country’s balance of payments. The other major component  is the  capital  and  financial  account,  which records  capital  flows and  transfers.  The balance  of payments  is organized  on  the  basis of the  double entry accounting principle; it records economic transactions  between residents and nonresidents of a country in the form of two offsetting entries, a credit and a debit. A credit entry in the current  account is a source of foreign exchange, which implies an increase in the financial assets acquired  from the rest of the world. It is thus recorded as a debit entry in the capital and financial account.  For this reason, a surplus or deficit in the current  account  is offset by a deficit or surplus in the capital and financial account. In other  words, a country  running  a deficit in the current account is a net debtor from the rest of the world whereas a country running a surplus is a net creditor to the rest of the world. It should  be observed that the  relationship  between  the  current   account  and the capital and financial account  holds true through accounting identity.

The balance on the current  account can be seen as being constituted by the balance on goods trade, the balance on services trade, the balance on income, and the balance on current  transfers.  While the current account  is conceptually  different  from  the  balance on goods and services trade,  a deficit or surplus  in the current  account is often driven by a trade deficit and surplus. This is because exports and imports  of goods and services are often the biggest—in terms of value—components of the current  account.

Bibliography: 

  1. Jörg Decressin and Piti Disyatat, “Productivity Shocks and  the  Current  Account: An Alternative Perspective of Capital Market Integration,” Journal of International Money and Finance (v.27/6, 2008);
  2. Giancarlo Gandolfo, International Finance and Open-Economy Macroeconomics (Springer-Verlag, 2001);
  3. International Monetary Fund, Balance of Payments Manual, 5th ed. (1993);
  4. Rita M. Maldonado, “Recording and Classifying Transactions in the Balance of Payments,” International Journal of Accounting (v.15, 1979);
  5. Robert M. Stern, The Balance of Payments: Theory and Economic Policy (Aldine, 1973);
  6. S. Department of Commerce, The Balance of Payments of the United States: Concepts, Data Sources, and Estimating Procedures (U.S. Government Printing Office, 1990).

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