2.1.4 Balance Of Payments Flashcards
Balance of payments
records all financial transactions made between consumers, businesses and the government in one country with other nations
The Current Account
is comprised of the balance of trade in goods, services, net investment incomes and net transfers
Current account deficit
there is a net outflow of demand and income from the circular flow (more money flowing out)
Current account surplus
there is a net inflow of demand and income from the circular flow (more money flowing in)
- Britain runs a strong surplus in services (Ireland) but a large rising deficit in goods (Germany)
Examples of countries with a big balance of payments surplus
South Korea, Germany and China
Countries with a big balance of payment deficit
UK, Brazil
Outflows of foreign currency
negative entries (when money flows out of the country)
Examples of outflows of foreign currency
- imported goods
- payments to world bank
- AID to other countries
- when immigrants working in the country send money back to their country
Inflows of foreign currency: positive entries (when money flows into the country)
Inflows of foreign currency
positive entries (when money flows into the country)
Examples of Inflows of foreign currency
- Exports sold
- UK citizens working in other countries
The interconnectedness of economies through international trade
- Globalisation
- Proportion of GDP that is trade is growing
- Own more assets overseas
- More migration
- Technology and sharing
Components in the current account of the Balance of Payment
- Trade Balance in Goods
- Trade Balance in Services
- Net Investment income from Overseas Assets
- Net Money Transfers
Trade Balance in Goods in the current account of the Balance of Payments
- finished manufactured goods, raw materials
- energy products, capital technology
Trade Balance in Services in the current account of the Balance of Payments
- Banking, Insurance, Consultancy
- Tourism, Transport, Logistics
- Shipping, Education, Health
- Research, Cultural arts
Net Investment income from Overseas Assets in the current account of the Balance of Payments
Profits, interest and dividends from investments in other countries (e.g the profits from transnational businesses)
Net Money Transfers in the current account of the Balance of Payments
- Overseas aid/debt relief
- Private money transfers (e.g from migrants)
Causes of a current account deficit
- Poorer price and non-price competitiveness
- Strong exchange rate affecting exports and imports
- Recession in one or more major trade partner countries
- Volatile global prices (e.g Commodities)
- Recession in one or more major trade partner countries
- Volatile global prices (e.g Commodities)
Poorer prices in a current account deficit
- Countries with higher inflation than trading partners
- Countries with low levels of capital investments & research
- Countries with weakness in design, branding
Strong exchange rate in a current account deficit
- High currency values increases prices of exports
- Appreciating currency also makes imports cheaper
Recession in major trade partner countries in a current account deficit
- Recession cuts value of exports to these countries
- Might be barriers to switching to other markets
- e.g. UK businesses struggle to sell to emerging markets
Volatile global prices in a current account deficit
- Exporter of primary commodities might be hit by a all in world prices
- Importing nations could be hit by higher prices for oil and gas
Reasons for UK’s persistent trade deficit
- High income elasticity of demand (Yed) for imported goods and services
- weakness on supply-side of the economy
- UK businesses finding it hard to finance a rise in exports (effects of credit squeeze)
- Majority of British exports go to slower-growing countries in Europe
UK’s persistent trade deficit (High income elasticity)
demand for imports grows strongly when consumer spending is rising
UK’s persistent trade deficit (weaknesses on supply-side)
Low research and development spending, low rate of capital investment
UK’s persistent trade deficit (British exports)
Majority of British exports go to slower-growing countries in Europe
- e.g. Ireland, Spain and also the USA. Less successful in exporting to emerging nations
Economic problems from Persistent Trade Deficits
- Loss of aggregate demand = slower real GDP growth and reduced living standards
- Loss of jobs in home-based industries = regional decline and structural unemployment problems
- currency weakness and higher inflation and a country may run short of vital foreign currency reserves
- might be a reflection of lack of competitiveness/ supply-side weaknesses
Problems from running trade surpluses
- If GDP is close to capacity, a rise in the trade surplus = demand-pull inflation
- lead to threat of
protectionism from trade deficit nations - If the surplus is due to high saving / low consumption = living standards might be too low
- might be result of exporting high-priced commodities (prices are volatile/unpredictable)
Government macroeconomic objectives:
a) Economic growth
b) Low unemployment
c) low & stable rate of inflation
d) Balance of payments equilibrium on current account
e) Balanced government budget
f) Protection of the environment
g) Greater income equality
Economic Policies to Reduce a Trade Deficit
- Demand management (a tightening of fiscal or monetary policy
- Supply-side improvements (policies to raise labour productivity and encourage start-ups with export potential)
- Protectionist measures such as import quotas and tariffs
Demand management
- A tightening of fiscal or monetary policy = reduced real spending power of consumers = lower spending on imports (fall in M improves trade balance)
- Lower exchange rate = reduced foreign price of exports = expensive imports = causes changes in demand
Supply-side improvements
- Policies to raise labour productivity and encourage start-ups with export potential (e.g Life sciences)
- Investment in human capital to boost productive capacity and competitiveness in high-value industries (e.g engineering, medicine)
What is the impact of a weak currency?
o Companies are cheap = negative primary income flows (e.g football companies are owned by foreigners/Cadbury is American due to weak pound = money to flow out of UK)
o Money flowing out, primary income is less
o UK used to have primary income surplus
