Saturday 9 August 2008

The current account deficit

At Infometrics Matthew Nolan has a piece on the current account deficit or the capital account surplus, depending on how you want to think about it.

A current account deficit is one of these issues non-economists get worked up about but economists, by and large, don't. Why? As Matt points out
It appears that the recent increase in our current account deficit is the result of both rising consumption and rising investment.
So what is wrong with more consumption or investment?
On the investment side, the idea of borrowing now to fund capital expenditure is a fairly mundane concept. The benefit of an investment project will materialise over time, while a disproportionate portion of the cost is incurred straight away. As long as the benefit of the investment exceeds the cost over the investments lifetime, and the risks are known, then there is no reason to be concerned about this form of borrowing.
What about the consumption side? Matt writes
On the consumption side, a nation may spend more than it earns because it either anticipates that it will grow in the future or it may substantially favour spending now ahead of spending in the future. As the goal of policy should be to maximise society’s lifetime happiness, if individuals want to consume more now (to the detriment of future consumption opportunities) they should be allowed to.

For a household, this type of borrowing is equivalent to “smoothing” the amount you consume over time. When you are young, you expect your lifetime earnings to increase in the future – as a result it is in your interest to borrow now. As a nation, we expect our lifetime earnings to increase in the future – and as a result, if we are offered credit at attractive rates we will be willing to borrow now.
Thus should we worry about the current account deficit,
The current account deficit is merely the result of the borrowing, consumption, and investment decisions of every household and firm in the economy. As long as these households and firms are fully informed of the risk and return associated with their borrowing decisions, is there really any reason to fear the spectre of a current account deficit?
The short answer to his question is, no.

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