Current Account Deficit: Good or Bad

Current account deficits are a topic of debate among economists. Different economists have varying opinions on whether these deficits are good, bad or do not matter altogether. Trade deficits can be problematic as countries that are borrowing from other countries or selling off their assets in order to finance their current purchases are risking the undermining of future production. Thus a permanent current account deficit is not a viable strategy in the long run. Employment could also be affected by high trade deficits. If imports exceed exports then workers lose their jobs to those abroad. Current account deficits can be seen as arising from bad central bank policies i.e. loose monetary policies. Increasing demand for imports may lead to rising inflationary pressure which includes higher prices in the countries that are exporting the goods.

On the other hand, current account deficits can be viewed as a sign of positive economic development i.e. a higher income level, consumer confidence and investment. They help in importing capital to finance investments in production capacity. In fact, data proves that at times of higher current account deficit, unemployment levels were at their lowest.

Current account deficit can also be seen as a sign of consumer preferences and thus not good or bad. Since economic well-being and increasing consumption are related, high demand for imported goods may be an indication of a successful economy.

Current account deficit might be used in the financing of investments that might give a rate of return greater than that of the debt. In such a scenario, current account deficit is not necessarily a bad thing.

However there seems to be a consensus that if current account deficit is used in the financing of investments that give a rate of return greater than that of the debt, it can be viewed positively. However, if it is used for current consumption and not for long term investments, it can be harmful.

Fiscal deficit: Good or bad

Fiscal deficit can be viewed through three different schools of thought: Keynesian, Ricardian and neo classical. According to the Keynesian point of view, government expenditure through deficit financing can help employ unused resources. The Ricardian view argues that consumers cut consumption as they anticipate that they will have to pay higher taxes to pay off any debt. According to the neo classical school of thought, an increase in government expenditure has a negative impact on savings that affects growth. This leads to crowding out or an increase in interest rate.

John Maynard Keynes believed that fiscal deficit was essential for countries to get out of an economic recession. Subsidies meant for the poor can help increase their disposable income. This shall not only improve their standard of living but also when they start consuming more goods and services, the aggregate demand for these goods shall increase leading to a boost in the economy.

Sustained high fiscal deficits would lead a government to increase its borrowing substantially, leading to an increase in interest rates and printing more money in order to decrease the gap. A rise in inflation will occur. The government will have to borrow not just to repay the loans but to pay even the interest on those loans. As the interest payments get high enough, it leads to a drag on economic growth.

This is a debt trap and shall hurl the country towards bankruptcy in the future. This creates the possibility of a sovereign default i.e. the country defaulting on its loans.

But fiscal deficit is necessary for counter cyclical fiscal policy. Deficits should be run during recession to compensate the shortage in the aggregate demand, but during boom there should be surpluses in order to avoid structural deficit. However fiscal conservatives (critics of Keynesian economics) believe that governments should always run balanced budgets and in case there are debts that need to be paid, surpluses should occur.

However, Chartalists believe that deficit spending is needed to create money supply or to satisfy any demand for savings more than that can be met by private investment.

Fiscal deficit can be viewed as good or bad depending on the context. If deficit is used to finance projects that shall lead to economic well-being and progress in the long run, they are good. However, if there is frivolous spending, these deficits can be seen as unsustainable and damaging in the long run.