The External Balance

THE EXTERNAL BALANCE

The internal & external balance are very important for all trading nations. Together, they make up the CURRENT ACCOUNT BALANCE.

Current Account: Part of the balance of payments account (record of financial dealings over a period of time between one country and all others) where payments for the purchase and sale of the goods & services are recorded.

Internal Balance: A situation in which aggregate demand = potential output.

External Balance: A situation for a country when the current account of the balance of payments is zero.

Imports of a country are a nations spending on foreign goods & services, and should be financed by exporting the country's own goods & services. If imports exceed exports, this must be financed by borrowing money or by running down savings held abroad.

CURRENT ACCOUNT DEFICIT: When imports exceed exports

Deficit problems: Foreign banks may refuse to lend any more money. This leads to a cut in domestic spending to curb the demand for imports. Side-effects of this include reduced economic growth and rising unemployment. This is known as a 'CREDIT CRUNCH'.

CURRENT ACCOUNT SURPLUS: When exports exceed imports.

Surplus problems: Firstly, surpluses reduce resources available for consumption. Without them, resources could be diverted to produce consumer goods or to increase exports. Secondly, a surplus reduces the amount of resources available for other countries. Therefore, for every surplus, there will be a deficit somewhere down the line. Countries with Current Account Deficits would require another country to reduce its surplus in order