Current account deficits — causes and consequences

Two deficits, two different endings

The United Kingdom has had a current account deficit in every year since 1984. In 2025 it was 3.0% of GDP (ONS). The country has not had a crisis because of it.

Thailand had a current account deficit of about 8% of GDP in 1995 and again in 1996 (IMF). In July 1997 its currency collapsed, and in 1998 its economy shrank by about a tenth.

The last lecture showed that a deficit never means money vanishing: the country borrows from abroad or sells assets. It ended by asking whether that matters. The two cases above show that the answer is not simply yes or no. So this lecture gives you the questions that decide the verdict: why the deficit happens, how it is paid for, and what the money is used for.

A deficit seen from inside the country

The last lecture looked at a deficit from the outside, through the accounts with the rest of the world. Now look from the inside. Use the national income lecture's equation, leaving out income from abroad for simplicity.

A country's national saving is the part of its income that households and the government do not spend on consumption: $S=\text{GDP}-C-G$. Put that into the equation and rearrange. The result is short and very useful.

This is an identity, like the one in the last lecture. It does not say which side causes the other. But it changes the question. A deficit can come from high investment, such as new factories, ports and power lines. Or it can come from low saving, such as households and a government spending most of what they earn. The deficit can be the same size in both cases. The future is very different.

Why deficits happen

Economists sort the causes into two groups. The test is simple. Imagine the economy growing at its normal pace. Would the deficit still be there?

A cyclical deficit is caused by the stage of the business cycle. In a boom, incomes rise, and people and firms buy more of everything, including imports. When the boom ends, imports fall and the deficit shrinks. A recession in a country's main trading partner works the same way, through exports instead.

A structural deficit stays through good years and bad. Its causes are long-lasting:

• Weak competitiveness. If wages rise faster than output per worker for years, the cost of producing each unit rises. Exports become expensive compared with rivals'.
• A strong currency. If the currency stays high for years, exports cost more in foreign currency, and imports are cheap at home.
• Lost industries. When an export industry closes or moves abroad, the country has less to sell.
• Low national saving. If households and the government save little in every year, then $S-I$ stays negative.
• Past borrowing. Every year of deficits adds to the assets that foreigners own in the country. They earn interest, dividends and profits, which are debits in primary income. So past deficits make future deficits larger.

Sort some causes yourself below.

What should you have noticed? The cyclical causes cure themselves as the cycle turns, and the structural causes do not. A government that mistakes one for the other will wait for a recovery that does not fix the deficit.

What a deficit leads to

1. Debts and income flowing out in future. Every deficit must be paid for by borrowing from abroad, selling assets to foreigners, or using reserves. Each of these has a cost later.

2. Pressure on the exchange rate, if the money stops coming. Paying for imports means selling the home currency, which pushes it down. But foreigners who buy the country's bonds, shares and firms must buy the home currency first, which pushes it up. While they keep coming, the two can balance. When they lose confidence, the currency must fall until spending on imports shrinks to what the country can pay for.

With a floating exchange rate, the fall happens in the market, and it is called a depreciation. With a fixed rate, the central bank sells its reserves to hold the rate up. That works only until the reserves run low. Then the rate has to be cut, a devaluation, often suddenly.

3. A sudden stop. Money that buys a factory is hard to take back out. Short-term loans and quick share purchases can leave in weeks. If inflows stop all at once, which is called a sudden stop, the country must cut its deficit at once, usually through a deep recession. It is worse if the debts are in a foreign currency, such as dollars. Then a fall in the home currency makes every debt bigger when measured in the home currency. This danger is called a currency mismatch.

Does a falling currency fix the deficit?

A fall in the currency makes exports cheaper for foreigners and imports dearer at home. So it should shrink the deficit. Eventually it often does. But at first it usually makes the deficit bigger.

Here is why. The causes of inflation lecture showed that a 20% fall in a currency raises import prices by 25%, because $1÷0.8=1.25$. That happens at once. But quantities change slowly. Orders are already signed, and buyers take time to find new suppliers. For the first months, the country buys almost the same imports at higher prices, so the import bill jumps. Only later do foreign buyers order more of its cheaper exports, and home buyers switch away from dearer imports.

Plotted against time, the balance first falls and then rises, like the letter J. It is called the J-curve. See it for yourself below.

What should you have seen? With a fall of 20% and a fairly strong response, the balance drops from −10 to −37.5 at once, gets back to −10 after about six months, and ends near +4. Now weaken the response. The J loses its upturn, and the deficit ends worse than it began. A fall in the currency cures a deficit only if buyers respond strongly enough, and only after a delay. Pre-University lectures make this condition exact, under the name Marshall–Lerner condition.

A real case: Thailand, 1997

The policy. For years before 1997, Thailand held its currency, the baht, close to 25 baht per US dollar. The economy grew fast, and foreign banks and investors were eager to lend. The current account deficit reached about 8% of GDP in 1995 and 1996 (IMF). Foreign debt was about half of GDP, and some 40% of it was short-term (IMF, 1997). Much of it was borrowed in dollars, while the borrowers earned baht.

The prediction. This lecture's questions point to danger. The deficit was large. It was financed with short-term money, in a foreign currency. And the fixed rate meant that the central bank had to defend it with reserves.

What happened. In 1997 lenders began to doubt that the debts could be repaid. Money flowed out, and the Bank of Thailand spent its reserves defending the baht. By the start of July, its usable reserves had fallen to about $2.9 billion, against about $36.5 billion of short-term foreign debt (Sussangkarn, TDRI, 1999). On 2 July 1997 the baht was allowed to float. It fell to its weakest point, about 56 baht per dollar, in January 1998 (NESDB). Debts in dollars more than doubled when measured in baht. Real GDP fell by about 10% in 1998 (APEC, 2001). Imports collapsed, and the current account swung to a surplus of 12.8% of GDP (IMF).

The verdict. The deficit alone did not cause the crisis. Thailand also had a fixed exchange rate, short-term debts in dollars, and investment that earned little foreign currency. Together they made a sudden stop possible, and then made it very costly. Look at how the deficit was finally closed: not by the J-curve working smoothly, but by a recession that cut spending on imports. That is the price a country pays when the money stops before the deficit is cured.

So is the UK's deficit a problem?

Use the same questions. The UK's deficit in 2025 was 3.0% of GDP, smaller than Thailand's. It has lasted through booms and recessions since 1984, which suggests that much of it is structural. The pound floats, so there is no fixed rate to defend. And the UK government borrows in its own currency.

Economists still disagree about the risk. In January 2016, Bank of England Governor Mark Carney told Members of Parliament that the UK relied on "the kindness of strangers": foreign investors who could stop buying UK assets at any time. In 2017, two Bank of England economists disagreed on the Bank's staff blog. They found that from 2012 to 2016, the UK paid for its deficits mostly by selling some of its large foreign assets, not with new foreign money. In 2025, as the last lecture showed, the deficit was paid for mainly by foreigners buying UK shares and bonds.

So a fair verdict is this. The UK's deficit is a long-lasting weakness, not a crisis. It becomes dangerous if foreign investors lose confidence quickly. Compared with Thailand in 1997, the UK has three protections: a floating pound, debts in its own currency, and large assets abroad.

Surpluses are not automatically good either. Germany's current account surplus was more than 8% of GDP in 2015 and 2016 (Deutsche Bundesbank). By $X-M=S-I$, that means Germany saved far more than it invested at home, and lent the rest abroad. The European Commission judged this an imbalance. Every surplus is matched by deficits somewhere else, because one country's exports are another's imports. Inside the euro area, Spain's deficit reached about 10% of GDP in 2007, and Spain could not let its own currency fall. It closed the deficit through a long recession and lower costs, and it has had a surplus every year since 2013 (Funcas).

Three classic mistakes