What Is the Current Account?
The current account records a nation's transactions with the rest of the world—specifically its net trade ingoods and services, its net earnings on cross-border investments, and its net transfer payments—over a defined period, such as a year or a quarter. The current account deficit of the United States in Q2 of 2023 was negative $212.1 billion.
Key Takeaways
- The current account represents a country's imports and exports of goods and services, payments made to foreign investors, and transfers such as foreign aid.
- Thecurrent account may be positive (a surplus) or negative (a deficit); positive means the country is a net exporter and negative means it is a net importer of goods and services.
- A country's current account balance, whether positive or negative, will be equal but opposite to its capital account balance.
- The U.S. has a significant deficit in its current account.
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Understanding the Current Account
The current account is one-half of the balance of payments, the other half being the capital account. While the capital accountmeasures cross-border investments in financial instruments and changes in central bank reserves, the current account measures:
- Imports and exports of goods and services
- Payments to foreign holders of a country's investments
- Payments received from investments abroad
- Transfers such as foreign aid and remittances
A country's current account balance may be positive (a surplus) or negative (a deficit); in either case, the country's capital account balance will register an equal and opposite amount. Exports are recorded as credits in the balance of payments, while imports are recorded as debits.
A positive current account balanceindicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower. A current account surplus increases a nation's net foreign assets by the amount of the surplus, while a current account deficit decreases it by the amount of the deficit.
In keeping with double-entry bookkeeping, any credit in the current account (such as an export) will have a corresponding debit recorded in the capital account. The item received by the nation is recorded as a debit while the item given up in the transaction is recorded as a credit.
Special Considerations
Since the trade balance (exports minus imports) is generally the biggest determinant of the current account surplus or deficit, the currentaccount balance often displays a cyclical trend. During a strong economic expansion, import volumes typically surge; if exports are unable to grow at the same rate, the current account deficit will widen. Conversely, during a recession, the current account deficit will shrink if imports decline and exports increase to stronger economies.
The exchangerate exerts a significant influence on the trade balance, and by extension, on the current account. An overvalued currency makes imports cheaper and exports less competitive, thereby widening the current account deficit or narrowing the surplus. An undervalued currency, on the other hand, boosts exports and makes imports more expensive, thus increasing the current account surplus or narrowing the deficit.
Current Account Balances Worldwide
Nations with chronic current account deficits often come under increased investor scrutiny during periods of heightened uncertainty. The currencies of such nations often come under speculative attack during such times.
This creates a vicious circle in whichforeign exchange reserves are depleted to support the domestic currency, and this foreign exchange reserve depletion—combined with a deteriorating trade balance—puts further pressure on the currency. Embattled nations are often forced to take stringent measures to support the currency, such as raising interest rates and curbing currency outflows.
Current Account vs. Capital Account
Some countries will split the capital account into two top-level divisions (i.e., the financial account and the capital account). In this context, the financial account measures an increase or decrease in international ownership of assets, while the capital account measures financial transactions that do not affect income, production, or savings.
What Are Some Factors That Impact the Current Account?
A country's trade balance (exports minus imports) is generally the biggest determinant of whether the current account is a surplus or a deficit. During an economic expansion, import volumes typically increase, creating a current account deficit. However, during a recession, the current account will be a surplus if imports decline and exports increase. Exchange rates are another variable that can impact the current account.
What Is a Capital Account?
The capital account is one part of a country's balance of payments. It provides a summary of the country's capital expenditure and income. Sometimes the capital account is called the financial account, with a separate, usually very small, capital account listed separately. The summary of transactions consists of imports and exports of goods, services, capital, and transfer payments such as foreign aid and remittances.The capital account measures the changes in national ownership of assets, whereas the current account measures the country's net income.
What Is a Balance of Payments?
A country's balance of payments (BOP) is a statement of all transactions made between entities in that country and the rest of the world over a defined period, such as a quarter or a year. It includes both the current account and the capital account. In theory, the sum of all transactions recorded in the balance of payments should be zero; however, exchange rate fluctuations and differences in accounting practices may prevent this in practice.
The Bottom Line
A country's current account represents its imports and exports of goods and services, payments made to foreign investors, and transfers such as foreign aid. It can be thought of as the country's net income. If it is positive (a surplus) that indicates it exports more it important. A negative (deficit) current account indicates that the country imports more than it exports.
The current account balance should be equal but opposite to the country's capital account balance, which measures changes in the country's net asset ownership. Both measures, when taken together, give a picture of a country's global economic activity.
