Cyclical and structural causes of deficits; imports rising with income on the diagram; how deficits are financed and when they matter; expenditure reducing, expenditure switching and supply-side cures; surpluses and global imbalances.
The UK current account has been in deficit in every year since the mid-1980s. It averaged around 2% of GDP through the 2000s, widened to over 5% in 2016 as income from UK investments abroad fell, and reached −6.6% of GDP in the final quarter of 2014. It narrowed after the pound fell in 2016 and during the pandemic, and in the second quarter of 2026 it was −2.5% of GDP: a goods deficit, a services surplus, and a deficit on income and transfers.
The mirror image is a financial account surplus: each year foreigners buy more UK assets, companies, property, shares and gilts, than UK residents buy abroad. In 2016 the Governor of the Bank of England said the UK relied on “the kindness of strangers” to finance itself.
What causes a persistent deficit, does it matter, and what could close it?
Source: ONS, balance of payments, current account balance as a percentage of GDP (AA6H), 29 September 2026; Mark Carney, speech, 2016.
A current account deficit means spending on imports, plus income and transfers paid abroad, exceeds the equivalent earned from abroad. Cyclical causes: imports rise with income, so a fast-growing or consumption-led economy sucks in imports while exports depend on income abroad. Structural causes: weak competitiveness (low productivity, high unit labour costs, poor quality or design), an overvalued exchange rate, a shrunken manufacturing base, and a dependence on imported energy and food. A fall in investment income, as the UK saw after 2012, also widens the deficit. Surpluses in Germany, China, the Netherlands and the oil exporters are the other side: high saving, weak domestic demand, undervalued currencies.
The deficit is financed through the financial account: inward investment, foreign purchases of shares and bonds, bank lending. The consequences depend on that financing. A deficit matched by productive foreign investment can be benign; one financed by short-term “hot money” leaves a country exposed to a sudden stop, a currency fall and higher interest rates, as Britain found in 1976 and emerging economies have found repeatedly. A persistent deficit also means a growing stock of foreign claims and a drain of future income abroad.
Three policy routes. Expenditure reducing: tighter fiscal or monetary policy cuts income and so imports, at the cost of growth and jobs. Expenditure switching: a depreciation or protectionism moves spending from foreign to domestic goods, subject to Marshall–Lerner, the J-curve, retaliation and imported inflation. Supply-side: raising productivity, skills and investment to make exports competitive, slow but durable.
The UK has run a current account deficit every year since the 1980s. In 2026 it was still about 2.5% of GDP.
A deficit means the country buys more from the rest of the world than it sells to it, year after year. Somebody has to be paying for the difference.
Who?
The balance of payments always balances. A current account deficit is financed by a financial account surplus: foreigners accumulating claims on the UK. Mark Carney called it relying on “the kindness of strangers”. Whether that matters is the argument of this lesson.
Why income matters. Exports depend on demand abroad, so the X line is flat. Imports rise with our own income: here 30p of every pound. The two balance at an income of £1,000bn. But full employment is at £1,200bn, where imports are £360bn and the deficit is £60bn. A country that grows faster than its trading partners, or spends more on consumption, runs a deficit for that reason alone: the cyclical cause.
Check: Exports are £300bn and imports are 30% of national income. At a national income of £1,200bn the current account shows:
M = 0.3 × 1,200 = 360; X − M = 300 − 360 = −60.
Expenditure reducing. Cut aggregate demand until income falls back to £1,000bn and imports to £300bn. It works, and it costs £200bn of output and the jobs that go with it. This is why deficit countries resist it and why the IMF was so unpopular in the 1980s and 1990s for prescribing it. Surplus countries face no equivalent pressure to expand, which is the asymmetry at the heart of global imbalances.
Check: The government raises taxes and the Bank raises interest rates until national income falls from £1,200bn to £1,000bn. The deficit closes because:
Nothing about competitiveness has changed; the country has simply bought less of everything, including imports. The cure is a recession.
Expenditure switching. A depreciation makes exports cheaper abroad and imports dearer at home. The X line shifts up to X2 and the import line pivots down to M2. At full employment the deficit becomes a surplus of £60bn, with no loss of output; the economy can now balance at an income of £1,440bn. The catch: it needs Marshall–Lerner to hold, it takes time (the J-curve), and dearer imports raise inflation.
Teacher tip: Sterling fell about 15% after the 2016 referendum. Ask what happened to the deficit: it narrowed from over 5% of GDP to about 3%, but slowly, and import prices pushed CPI inflation to 3% in 2017. All three caveats in one episode.
Check: The pound depreciates. Exports rise to £360bn and imports fall to 25% of income. At £1,200bn the current account now shows:
X2 − M2 = 360 − 0.25 × 1,200 = 60. Spending has switched towards domestic goods at the same level of income.
The structural route. If British firms make better products at lower unit cost, exports rise and imports fall at any exchange rate: the same shift as a depreciation, but durable and without the inflation. The tools are the supply-side ones: skills, investment, infrastructure, research, competition. Protectionism also switches spending but at the cost of retaliation, higher prices and sheltered inefficiency, and WTO rules limit it.
Check: Which policy is most likely to reduce a structural current account deficit permanently?
A depreciation is eroded by the inflation it causes; a tariff invites retaliation; a recession ends. Only higher productivity shifts the X line up and the M line down for good.
The other side. The world’s current accounts sum to zero: Germany’s and China’s surpluses are America’s and Britain’s deficits. Surplus countries save more than they invest and lend the difference abroad; deficit countries borrow it. The burden of adjustment falls on deficit countries, because they can run out of finance, while surplus countries can continue indefinitely. That is why global imbalances persist.
Check: Germany ran current account surpluses of around 6 to 8% of GDP for most of the 2010s. From the point of view of its trading partners, the surplus:
Surpluses reflect saving in excess of investment at home; the counterpart is borrowing abroad. Keynes proposed penalising surpluses as well as deficits in 1944.
At Y = £800bn imports are £240bn and exports £300bn: a surplus of £60bn, not a deficit. Deficits occur to the right of the balance point, where the import line is above the export line.
Evaluate the policies a government could use to reduce a persistent current account deficit.
A current account deficit arises when spending on imports and income paid abroad exceeds export earnings and income received. It can be cyclical, because imports rise with national income while exports depend on income abroad, or structural, reflecting weak competitiveness, an overvalued currency or a dependence on imported energy. The UK has run one every year since the 1980s; it was 2.5% of GDP in mid-2026.
Expenditure-reducing policies cut aggregate demand through higher taxes, lower spending or higher interest rates. On the diagram, lower income moves the economy back along the import line until imports equal exports. It works, but by shrinking the economy: closing a £60bn deficit with an import ratio of 0.3 requires £200bn less income, with the unemployment that implies.
Expenditure-switching policies move spending from foreign to domestic goods at a given income. A depreciation shifts the export line up and pivots the import line down; after 2016 the pound fell about 15% and the UK deficit narrowed from over 5% of GDP to around 3%. But the Marshall–Lerner condition must hold, the J-curve means the deficit worsens first, and dearer imports raised inflation to 3% in 2017 and eroded the gain. Tariffs switch spending too, at the cost of retaliation, higher prices and sheltered inefficiency, within WTO limits.
Supply-side policies raise productivity, skills and investment so that exports compete on quality and cost at any exchange rate. This is the only route that shifts the lines permanently, but it takes a decade and its effects are uncertain.
**However,** the prior question is whether the deficit needs correcting. The UK’s is financed by inward investment in a country with a floating currency and debts in its own money, which is why forty years of deficits have produced no crisis; the real counterpart is low national saving, since (S − I) + (T − G) = X − M, so a smaller budget deficit would narrow the current account deficit without any trade policy at all. A deficit financed by short-term flows in a fixed-rate economy is a different matter and demands action.
On balance no single policy is adequate: expenditure reduction is too costly, switching too temporary, supply-side too slow. A credible mix, with higher national saving and investment in competitiveness, is the right answer for a deficit like the UK’s, and the case for urgency depends on how it is financed rather than on its size.
Current account figures: ONS, balance of payments, current account balance as a percentage of GDP (series AA6H), quarterly to 2026 Q2, released 29 September 2026. The export and import lines on the diagram are invented. Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed.