Final answer:
A decrease in a country's inflation rate could make its goods cheaper, leading to increased exports and improved current account balance. However, external factors such as foreign investment, currency strength, and global market conditions also play significant roles and can influence the outcome in complex ways.
Step-by-step explanation:
A fall in a country's inflation rate could potentially improve its current account position, but this is not guaranteed as several other factors come into play. Lower inflation can make a country's goods relatively cheaper on the international market, leading to increased exports and a reduction in the current account deficit. However, if a country's inflation rate falls below that of its trading partners, the country might experience an inflow of foreign capital, which can appreciate the domestic currency, making exports less competitive and imports cheaper. This could potentially worsen the current account.
When considering why a current account deficit might decline, we can look at the impact of higher unemployment and lower inflation, as observed in 2009. High unemployment may lead to lower domestic spending, including on imports, which could improve the current account balance. With regard to low inflation during financial crises, the cost of servicing debts at a fixed interest rate becomes more burdensome when real interest rates are positive, putting pressure on domestic spending and affecting the inflow and outflow of capital. Ironically, this situation could lead to an improved current account as imports may decrease.
Global financial confidence can also be a factor. A rising percentage of debt to GDP might create uncertainty, causing investors to hesitate in placing capital within the country. This could lead to reduced foreign investment, a key component of the current account.