Deficits can lower GDP and jobs and weaken the currency; surpluses can raise GDP and jobs but may add to inflation.
A deficit caused by falling exports or rising imports means less spending on the country's own output. GDP grows more slowly and employment may fall, especially in export and import-competing industries.
A deficit means more of the currency is sold than bought, so it tends to depreciate. A large, lasting deficit may need financing by borrowing or selling assets to foreigners. However, imports can reduce inflation by bringing cheaper goods.
A surplus means more spending on the country's output, so GDP and employment can rise. But if the economy is near full capacity, extra demand can push up inflation.
A surplus means more demand for the currency, so it tends to appreciate. That makes exports dearer and can reduce the surplus over time.
- Deficit
- Lower GDP growth and jobs; currency tends to depreciate; cheaper imports may lower inflation.
- Surplus
- Higher GDP and jobs; possible inflation; currency tends to appreciate.
Worked example: Tracing a surplus through the economy
Suppose a country's exports rise strongly, increasing its current account surplus.
- GDP: exporters produce more, so output rises.
- Employment: firms hire more workers.
- Inflation: if the economy is near full capacity, prices may rise.
- Exchange rate: foreigners buy more of the currency, so it appreciates, making exports dearer later.
Watch out for this
A current account surplus is always good for living standards.
A surplus can raise output and jobs, but it may mean people consume less than they produce, and it can cause inflation or currency appreciation.
Check your understanding
A country's current account deficit grows because imports rise sharply. What is the likely effect on its exchange rate?
- It depreciates, as more of the currency is sold to buy imports.
- It appreciates, as foreigners buy more of it.
- It is unaffected.