Does a current account deficit matter?

Yes according to economist Roger Bootle writing in the latest edition of the Deloitte Economic Review and reported in this article from the Financial Times.

“Britain is headed for its highest peacetime current account deficit and both household and government spending will have to slow painfully to correct it, according to economist Roger Bootle”

Last year the current account deficit was measured at just under £60 billion or just under 4 per cent of our national income - a reflection that the UK is not paying its way in the global economy. We have been able to rely on sufficient capital inflows to finance the deficit without too much economic pain, but Bootle argues that the deficit is symptomatic of a deeper malaise - excess consumption - and growth will have to slow down to bring the deficit down. Interestingly the FT article hints at a rule of thumb relationship between changes in the exchange rate and changes in the current account balance

“Most economic models suggest a 10 per cent drop in the nominal value of sterling should be associated with a narrowing of the current account deficit by around 0.5 per cent of GDP. But on that basis, the pound, which has already fallen by 10 per cent, would have to fall by another 70 per cent to close the deficit completely.”

This is useful as evaluation for any exam question on the link between movements in the exchange rate and changes to the trade balance.

Bootle writes that
“The UK cannot continue to borrow the equivalent of 4 per cent of its GDP from the rest of the world indefinitely,” Mr Bootle writes. “And it looks like we are getting close to payback time.”

The Deloitte Review can be downloaded here