Evaluate question 3

What is Current Account Deficit and Government Deficit and do they have any effect on Aggregate Demand and Supply?



Current account deficit means the expenditure on abroad exceed the revenues generated from abroad.It consist of net trade in goods and services, net transfer and net investment.

UK kept having a net trade in goods deficit for few years, this could shows that there are higher demand on imports, which is a leakage to the economy, AD=G+I+C+(X-M), a downward multiplier effect(diagram), it would leads to AD shift inwards.As UK has a strong exchange rate, the price on exports are high , the consumption on exports would tend to be low, the supplier would more likely to turn to domestic market or close down which cause an increase in unemployment and an inward shift of AS.However, it still largely depends on other factors such as whether the demand for the goods are price elastic or income elastic. The current situation of the market and the size of the current account deficit.Net investment which means the UK investors gain profit , interest and dividend on their investment in other countries to UK.The transfer balance is negative as the British government is a net contributor to the EU budget,so there may left less government spending, which would have less welfare benefits to unemployment, AS shift to left.


A current account deficit appear, the government tend to use monetary policy to adjust exchange rate to boost the demand for exports. Provide better information for supplier to improve better quality of the exported goods.Import control to protect domestic market and boost the demand, AD shift to right. Deflation to decrease the consumption on imports.

Government Deficit is budget deficit where government spending exceed tax revenue. For instance, huge government spending into the bank to boost demand. A budget deficit means government have to borrow to finance , the borrowing may through government bond or issue debt for domestic or overseas. No matter how it borrow, there is a interest need to pay. A way to pay that is by having a higher tax, but in this case, a higher tax would damage AD and AS.However, it still depends on what the government spending is used for? and the size of the deficit as well as the situation of the market. If the government spending used to finance extra capital spending that leads to an increase in the stock of national assets or for expand supply side capacity such as education and training, better health care, reduce unemployment, subsidy , it would have positive effect on AS. If the government spending priority is on defense or education, it would have negative effect on AS and AD, as there is a time lag for people to be educate as skillful labour. If the economy is currently have stable economic growth, a small budget deficit will not affect much on AD and AS.Government could cut down interest rate to boost demand to rise revenue from indirect tax to correct budget deficit.