A Discussion Of The UKs Current Account

A Discussion Of The UKs Current Account Deficit And Its Implications For The Private Citizen Essay, Research Paper Traditionally, Britain has been concerned with its BOP “problem”, most clearly demonstrated by the “stop-go” cycles of the Bretton Wood era. The record CA deficit of the late 80’s and the emergence of a BOT deficit in manufactures in the early 80’s for the first time in British economic history has renewed interest on the subject. During the last 2 or 3 decades, however, the importance and even the very existence of a BOP “problem” has been disputed : Free floating exchange rates, extensive international capital movements and a single currency have been proposed as ways to eliminate the BOP problem. More fundamentally, many people, including the

ex-Chancellor N. Lawson, have argued that, provided the public sector is in equilibrium, CA deficits are not a problem at all since they simply represent optimising behaviour decisions of the private sector. Intertemporal optimisation by economic agents and countries could well result in temporary but potentially protracted BOP disequilibria just as the life-cycle model for an individual agent suggests periods of saving (equivalent to a CA surplus) and dissaving (CA deficit). Examples may include Japan which because it has an ageing population, it may be building up international assets in order to use them for future consumption. Similarly, it could be argued that it may be efficient for Britain to smooth out its consumption from the unstable revenues from oil production by

resorting to the international financial markets. I believe that this theory has been very useful in dispelling the up to then prevalent view that every CA deficit is evil and has to be eliminated by government action as soon as possible. Nevertheless, this theory is often taken to extremes by arguing that every CA disequilibrium, caused by the private sector, is optimal and no policy response is needed. There are 2 main reasons why private optimising behaviour may not lead to socially optimum outcomes. The first refers to possible market failures, inefficiencies and even occasional irrationality of the financial markets (and of the private sector generally) which leads to all sorts of wasteful bubbles and subsequent crises. The debate about the efficiency of the financial system

is too big to report here but one can have a healthy doubt of the private sector’s optimal handling of its affairs. Secondly, there are externalities which the private sector may ignore when making its decisions: The governments may have to concern themselves with longer term issues (though it is not entirely clear if the government should have a different time preference than its citizens!) and with macroeconomic considerations which may not adequately be taken into account by private agents. An obvious example is the exchange rate, since -especially under a fixed ER regime- agents take the ER as given though their actions may lead to a depreciation and a subsequent fall in all the country’s purchasing power. The most important externality that the private sector may not

take into account is that eventually, when the CA has to be balanced, a recession may then ensue. The view that the extensive international K movement has removed the need to balance the BOP is clearly wrong since this would require ever increasing interest rates. Similarly, the opposite view that the fact the BOP has eventually to balanced by itself disqualify the “optimal deficit” theory as some articles appear to suggest is also wrong. The BOP is a problem not because it simply has to be balanced at some point, but because the adjustment needed may conflict with other economic objectives. In particular we shall focus on the case of a CA deficit since there is much less pressure for surplus countries to adjust. To see how this may happen we have to examine how can a CA