A country's current account deficit is equal to the net outflow of goods, services, investment income, and transfers. A country's current account can be in balance, in deficit, or in surplus at any given time. Whether in surplus or deficit, the current account's non-zero balance must be offset by an equal and opposite balance in the capital account. Taken together, the current account and capital account make up a country's balance of payments and must always equal zero.
To better understand a current account deficit, it is important to understand what is encompassed in the current account. The current account includes all items of income and outlay in a nation's economy: imports and exports of goods and services, investment income, and transfer payments. In the past, the balance of trade has been a focus of macroeconomists, with mercantilist policy focused on increasing exports and decreasing imports to obtain a trade surplus. Surpluses were thought of as favorable balances of trade, and many countries continue to work toward trade surpluses, believing they are best for the economy.
Modern macroeconomists try to focus more on the entirety of the current account balance, in part because trade deficits are not always bad for an economy, and in part because the transfer of services and investment income have come to play a more important role in international trade. Services in the current account include things such as foreign travel, shipping, and financial services. Investment income includes the earnings on foreign investments, or home-country assets abroad. The current account balance is the net of goods exported and imported, plus the net of services exported and imported, plus the net of investment income moving in and out of the country, plus net transfers, which represents payments not in return for goods and services such as foreign aid. Thus, depending on the volume of income and outlays, the current account can either be in surplus or deficit — or, theoretically, in perfect balance.
When the current account is in deficit, a country must find a way to pay for the additional goods and services it has purchased. The capital account consists of all asset transactions between the home country and other countries. In other words, the capital account includes all lending or borrowing between a country and others. Included in the capital account are private lending and borrowing, as well as government lending and borrowing, through either changes in official foreign reserves holdings or the buying and selling of government bonds. The key is that a current account deficit must be offset by a surplus in the capital account so the international balance of payments equals zero.
