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Consequences of a CAD & CAS (Current Account Surplus (Appreciation of…
Consequences of a CAD & CAS
Current Account Deficit
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High interest repayments
: Paying back loans to other countries as the spending within a country is being funded by savings and investment from abroad. This further worsens the CAD.
Countries may have fewer reserve assets as they're being used to balance the deficit, no country is rich enough to continually operate in by using their reserves to keep their current account level (unsustainable in the long-term).
Increased uncertainty resulting in decreased investment
: A CAD can create volatility in an economy, thus reducing consumer confidence which can lead to a decrease in investment.
Less foreign currency to purchase foreign goods and services
: This is due to the use of foreign assets to balance deficit.
Loss of sovereignty
: If a current account deficit becomes too large, this means that other economies control large amount of our currency. This can lead to a loss of sovereignty as we do not have supreme control over our currency.
Potential increase in free trade
: If a country utilises capital transfers to develop good relations with trade partners.
Depreciation in currency value
: As more of the domestic currency is sold through imports, its supply in the FOREX increases, thereby decreasing the amount of foreign currency it can purchase.
Reduced consumer confidence
: When a CAD is present, there is high levels of foreign investment into the country. These investors could potentially withdraw any time due to a variety of reasons, leaving a country without the ability to finance itself. This would then have other follow on effects and could further worsen the CAD.
Decrease in AD:
As the current account is primarily composed of the BOGS, greater imports than exports will lead to a decrease in AD.
Poor international credit ranking
: Agencies rank countries by "credit ratings" - how likely they are to repay loans. Countries with a greater CAD have low credit ratings, which increases the difficultly to get future loans (because no one wants to lend to a country that might not pay back the loan).
Current Account Surplus
Appreciation of domestic currency
: A current account surplus puts upward pressure on value of currency, which can lead to lower exports and higher imports (reduced net exports), which may have a negative effect on the domestic economy (lower AD).
Reduced export competitiveness
: As domestic currency appreciates, exports become more expensive to foreigners, and this makes it more difficult for domestic firms to compete with firms abroad.
Financial Account deficit would be needed to balance the payments - buying the debts of bonds from countries that have CADs - if they get in trouble, then you have potential worthless bonds
Increased confidence of foreign investors
: Due to the greater inflows within the economy, this encourages investors as they are lead to believe that this is an indication of a strong economy.
Low domestic consumption:
Current account surplus are net purchasers of assets abroad or net lenders to other countries thus, having financial account deficit. So, with a current account surplus comes lower consumption levels and lower standards of living for the population relative to where a country has a current account deficit or a balanced current account where credits = debits.
Increased foreign currency gives the economy more ability to purchase foreign assets.
Increased protectionism
? A current account surplus in one economy means there are current account deficits in other countries.
Insufficient domestic investment:
Financial account deficit means that funds are leaving the country, resulting in a risk of insufficient domestic investment because
Might harm International relations - if it is a manufactured CAS therefore countries with CADs might not be happy with what is happening and retaliate