Current Account: Definition and What Influences It

What Is the 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 current account deficit of the United States in Q2 of 2023 was negative $212.1 billion.

Understanding the 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
• 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.

Special Considerations

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.

The Bottom Line

A country's current account represents its imports and exports of goods and services, payments made to foreign investors, and transfers such as foreign aid. It can be thought of as the country's net income. If it is positive (a surplus) that indicates it exports more it important. A negative (deficit) current account indicates that the country imports more than it exports.

The current account balance should be equal but opposite to the country's capital account balance, which measures changes in the country's net asset ownership. Both measures, when taken together, give a picture of a country's global economic activity.