What Is Current Account?
The current account records a nation's transactions with the rest of the world—specifically its net trade in goods and services, its net earnings on cross-border investments, and its net transfer payments—over a defined period, such as a year or a quarter. The Q3 2021 current account of the U.S. was $-190.3 billion.
- The current account represents a country's imports and exports of goods and services, payments made to foreign investors, and transfers such as foreign aid.
- The current account may be positive (a surplus) or negative (a deficit); positive means the country is a net exporter and negative means it is a net importer of goods and services.
- A country's current account balance, whether positive or negative, will be equal but opposite to its capital account balance.
- The U.S. has a significant deficit in its current account.
Understanding Current Account
The current account is one-half of the balance of payments, the other half being the capital account. While the capital account measures cross-border investments in financial instruments and changes in central bank reserves, the current account measures imports and exports of goods and services, payments to foreign holders of a country's investments, payments received from investments abroad, and transfers such as foreign aid and remittances.
A country's current account balance may be positive (a surplus) or negative (a deficit); in either case, the country's capital account balance will register an equal and opposite amount. Exports are recorded as credits in the balance of payments, while imports are recorded as debits.
A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower. A current account surplus increases a nation's net foreign assets by the amount of the surplus, while a current account deficit decreases it by the amount of the deficit.
In keeping with double-entry bookkeeping, any credit in the current account (such as an export) will have a corresponding debit recorded in the capital account. The item received by the nation is recorded as a debit while the item given up in the transaction is recorded as a credit.
Since the trade balance (exports minus imports) is generally the biggest determinant of the current account surplus or deficit, the current account balance often displays a cyclical trend. During a strong economic expansion, import volumes typically surge; if exports are unable to grow at the same rate, the current account deficit will widen. Conversely, during a recession, the current account deficit will shrink if imports decline and exports increase to stronger economies.
The exchange rate exerts a significant influence on the trade balance, and by extension, on the current account. An overvalued currency makes imports cheaper and exports less competitive, thereby widening the current account deficit or narrowing the surplus. An undervalued currency, on the other hand, boosts exports and makes imports more expensive, thus increasing the current account surplus or narrowing the deficit.
Nations with chronic current account deficits often come under increased investor scrutiny during periods of heightened uncertainty. The currencies of such nations often come under speculative attack during such times.
This creates a vicious circle in which foreign exchange reserves are depleted to support the domestic currency, and this foreign exchange reserve depletion—combined with a deteriorating trade balance—puts further pressure on the currency. Embattled nations are often forced to take stringent measures to support the currency, such as raising interest rates and curbing currency outflows.
Current Account vs. Capital Account
Some countries will split the capital account into two top-level divisions (i.e., the financial account and the capital account). In this context, the financial account measures an increase or decrease in international ownership of assets, while the capital account measures financial transactions that do not affect income, production, or savings.
What are some factors that can impact the current account?
A country's trade balance (exports minus imports) is generally the biggest determinant of whether the current account is in a surplus or deficit. During a strong economic expansion, import volumes typically surge and, if exports are unable to grow at the same rate, the current account will be in deficit. Conversely, during a recession, the current account will show a surplus if imports decline and exports increase to stronger economies. Exchange rates are another variable that can impact the current account.
What is a capital account?
The capital account is one part of a country's balance of payments and provides a summary of the capital expenditure and income for a country. Sometimes the capital account is called the financial account, with a separate, usually very small, capital account listed separately. The summary of transactions consists of imports and exports of goods, services, capital, and transfer payments such as foreign aid and remittances. Essentially, the capital account measures the changes in national ownership of assets, whereas the current account measures the country's net income.
What is balance of payments?
A country's balance of payments (BOP) is a statement of all transactions made between entities in that country and the rest of the world over a defined period, such as a quarter or a year. It includes both the current account and capital account. In theory, the sum of all transactions recorded in the balance of payments should be zero, however, exchange rate fluctuations and differences in accounting practices may hinder this in practice.