The Current Acccount vs the Trade Deficit
Here is a brief overview.
Professor Mankiw, Would you please discuss the differences between current account deficits and trade deficits? They are often discussed as if they were interchangeable, but I notice that for some countries they diverge significantly.
The trade balance is the amount a country receives for the export of goods and services minus the amount it pays for its import of goods and services.
The current account is the trade balance plus the net amount received for domestically-owned factors of production used abroad.
Hence, if an American owns an apartment building in London, the rent he receives is part of the current account but not part of the trade balance. In essence, the current account is a very broad measure of the trade balance where the income from domestically-owned factors used abroad are considered an export of factor services and the payments for foreign-owned factors used here are considered an import of factor services. To continue our example, the current account treats our American landlord as if he were an exporter of housing services.
Two things to note: 1. If a Brit owns an apartment building in Boston, the treatment of the rent he receives is similar, but with the opposite sign for the U.S. current account balance. 2. When an American buys an apartment building in London (or a Brit in Boston), that purchase appears neither in the trade balance nor in the current account. It is a capital account transaction.
You might ask, when we write Y=C+I+G+NX, what is NX? The answer depends on how we define Y. If Y is Gross Domestic Product, then NX is the trade balance. If Y is Gross National Product, then NX is the current account.
For the U.S. economy, these two measures are close, and so economists sometimes use the terms interchangeably (even though they are not precisely the same). But for countries with large net foreign assets or debts, the difference can be larger.