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An introduction to the uk governmetn and current account deficit

Many economists, including the IMF and FPC have suggested the UK is therefore vulnerable to foreign investors becoming less willing to invest in the country. Looking at gross, rather than net capital flows since 2012 suggests inflows have been extremely subdued relative to past levels.

  • However, exchange rate falls cannot explain all of the growing blue bars see for example Figure 10a in this paper;
  • External imbalances that are associated with rapid inflows of capital are more likely to be associated with rapid domestic balance sheet expansion and often fast domestic credit growth;
  • Capital gains — for example, unrealised gains in the value of equities and bonds held by UK investors overseas — are likely to explain some of the remainder;
  • And in the financial account, assets pertaining to international monetary flows of, for example, business or portfolio investments are noted;
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  • Back to table of contents 6.

Instead, the UK has benefitted from increasing capital gains on past foreign investments and used these to fund its spending. We argue this carries lower financial stability risks than relying on gross inflows to cover the current account deficit.

To understand why, remember first of all that the two most important components of a current account balance are the trade balance, or the difference between what the country exports and what it imports, and the primary income balance, which includes the difference between investment income earned abroad by residents, and that earned domestically by non-residents.

  1. One might then ask.
  2. It is also known as the "consenting adults" view of the current account, as it holds that deficits are not a problem if they result from private sector agents engaging in mutually beneficial trade.
  3. Within the BOP there are three separate categories under which different transactions are categorized. 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.
  4. Download this chart Image.

One way of financing a current account deficit is through foreign investment in UK financial or physical assets. In fact, between 2012 and 2016, there was no kindness at all: In other words, non-residents actually ran down their holdings of UK assets, rather than helping to fund the deficit. Instead, the UK has cashed in on some of its past investment abroad to fund its foreign spending: Further, despite the sales of foreign assets by UK residents, the overall value of these assets has not fallen over the same period, because of so-called revaluation effects.

Revaluation effects do not reflect sales of assets or liabilities from one country to another, but capture a change in their nominal value see this ONS analysis.

That more than offset the sales of assets needed to finance the deficits on trade and investment income the red and yellow bars respectively. However, exchange rate falls cannot explain all of the growing blue bars see for example Figure 10a in this paper.

Capital gains — for example, unrealised gains in the value of equities and bonds held by UK investors overseas — are likely to explain some of the remainder. The FPC has been drawing attention to the size of the current account imbalance itself i.

But we believe gross flows are likely to be at least as important as net flows as an indicator of vulnerability as has been argued by Forbes and WarnockObstfeld and Shin. When a current account deficit is financed by gross inflows, new liabilities are created which domestic residents have to pay off. External imbalances that are associated with rapid inflows of capital are more likely to be associated with rapid domestic balance sheet expansion and often fast domestic credit growth.

If these lending flows stop, say because foreign investors take fright, then some domestic residents may find themselves facing cash-flow problems or much higher borrowing rates, leading them to cut spending. But it has not been the case recently. We use a cross-country sample of 185 episodes of sudden stops in external financing in advanced and emerging countries since the 1980s, based on the identification proposed by Forbes and Warnock.

The chart shows the observed frequencies, given different levels of inflows. We want to draw attention to two points here.

UK

First, there is a clear positive relationship: Based on this evidence, the UK would be relatively unlikely to experience a stop in financing flows in the near future. An extreme reversal of attitudes to the UK— so that foreigners not only stop investing in the UK, but sell off their existing holdings — would clearly have large effects on UK asset prices.

The current UK experience raises some interesting research questions. What exactly are these large revaluation effects which have raised the net international investment position so much? We would be interested to hear from any researchers who have insights to share on these or on related questions, or who would be interested in collaborating with us on future work.

Current account

If you want to get in touch, please email us at bankunderground bankofengland. Comments will only appear once approved by a moderator, and are only published where a full name is supplied. Bank Underground is a blog for Bank of England staff to share views that challenge — or support — prevailing policy orthodoxies.

  • Balance of payments The balance of payments BOP is the place where countries record their monetary transactions with the rest of the world;
  • Back to table of contents 5;
  • And in the financial account, assets pertaining to international monetary flows of, for example, business or portfolio investments are noted;
  • Also available is an overview of how movements in foreign exchange rates can impact the balance of payments and international investment position;
  • But it has not been the case recently;
  • Less obvious methods to reduce a current account deficit include measures that increase domestic savings or reduced domestic borrowing , including a reduction in borrowing by the national government.

The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.