Question

(Related to Solved Problem 29.1 on page 1034 ) An article on the Dow Jones Newswire in mid-2017 contained the following sentence: "The U.S. current- account deficit, a measure of trade and financial flows with foreign countries widened to \(\$ 116.78\) billion in the first quarter." Does a country's current account include any financial flows between that country and other countries? Does it include all financial flows between that country and other countries? Briefly explain.

Short answer

The current account of a country does include financial flows between that country and the rest of the world, but it does not include all such flows. It consists of trade in goods and services, income receipts and payments, and unilateral transfers, but excludes the purchases of assets like land or financial securities which are recorded in the capital or financial account.

Step-by-step solution

Define Current Account

The current account of a country is a part of its balance of payments, it keeps a record of all transactions made between the country and the rest of the world in a certain period. It includes three categories: trade in goods and services, income receipts and payments, and unilateral transfers.

Explain what the Current Account includes

The current account includes transactions involving goods, services, income, and unilateral transfers. Trade includes exports and imports of both goods and services. Income includes earnings on foreign investments and payment made to foreign investors. Unilateral transfers include gifts, aids etc. from one country to another.

Interpret all the financial flows

The current account does include financial flows between a country and the rest of the world, but it does not include all financial flows. It is important to understand that there are transactions that are recorded, not in the current account, but in the capital account or financial account of balance of payments. This includes transactions such as purchases of assets like land or financial securities.

Key concepts

Trade in Goods and Services

When discussing the current account balance of payments, trade in goods and services is a fundamental concept. It encompasses the import and export of physical products like cars, electronics, and agriculture, as well as intangible services such as banking, insurance, and tourism. A country earns currency from its exports while it spends on imports. This component helps in understanding a nation's economic health.

Essentially, if a country exports more than it imports, it has a trade surplus; conversely, if it imports more than it exports, it has a trade deficit. These figures are crucial because they can affect the exchange rate of a nation's currency, impact domestic industries, and signal economic policies that governments might need to adjust.

Income Receipts and Payments

Income receipts and payments refer to the cross-border flows of income from investments and work. They are an integral part of a country's current account. Income receipts include the money a country earns from investments abroad and compensation for residents working in foreign countries. Conversely, payments are the outflows to foreign investors in a country's domestic market or wages paid to foreign workers.

Understanding this dynamic is crucial. High income receipts suggest that a country's investments or workforce abroad are doing well, whereas high payments might indicate a substantial foreign participation in the domestic economy. It's these flows that solidify the connection between economies, impacting currency strength and offering insights into international economic engagement.

Unilateral Transfers

Unilateral transfers are one-way flows of assets without a quid pro quo. These are often seen in the form of gifts, grants, or remittances sent by residents to non-residents or vice versa. Unlike trade and investments, these do not come with an expectation of economic return and are rather based on benevolence or familial ties.

Remittances, for example, are a large part of unilateral transfers for many countries where the workforce is employed abroad. These transactions reflect a fundamental social and humanitarian aspect of global economics and can have a profound effect on consumption, saving patterns, and even poverty levels in recipient countries.

Capital Account Transactions

Capital account transactions are sometimes confused with the current account but are distinctly different. They include the purchase and sale of real assets (like property) and financial assets (like stocks and bonds) across borders. Understanding these transactions is crucial for grasping the complete picture of a country's economic interactions with the world.

For instance, when a country sells a piece of real estate to a foreign investor, it is recorded in the capital account, not the current account. These transactions affect the demand for a nation's currency and can influence the country's financial stability. Capital account transactions are a testament to the globalizing world where assets are as mobile as goods and services.