Consequences of a deficit
A deficit means that a country is consuming more than it is producing.
- If a deficit increases, it will reduce AD in the economy - this will lower economy's output, be likely to raise unemployment and may put a downward pressure on the price level.
- A rise in the deficit is also likely to lead to a fall in the exchange rate and increase the debt of the country.
Consequences of a surplus
A surplus means a country is consuming less than it is producing and is experiencing a net inflow of money and income.
The increase in the money supply - banks have more money - can increase bank lending.
A rise in a surplus will mean that net exports are increasing. This will raise AD and be likely to push up the exchange rate.
Significance of a current account deficit
Size - a deficit that forms a small percentage of real GDP or one that lasts a short time is UNLIKELY to be very significant.
What is happening in the capital and financial account
Significance of a deficit
The effect of a current account deficit on an economy is also influenced by what is happening to the other main sector of the balance of payments.
E.g. FDI, net inflow of portfolio investment. These movements in capital and financial capital meant that, despite the current account deficit, the value of the pound remained high and stable.