2.1.4 Balance of payments Flashcards
Balance of payments
The balance of payments is a record of all financial dealings over a period of time between economic agents of one country and all other countries. Imports are when goods/services come in, so money goes out. Exports are when money comes in, so the good/service goes out.
Components of the balance of payment
● The balance of payments is made up of the current account which records payments for the purchase and sale of goods and services; and the capital and financial account which records flows of money associated with saving, investment, speculation and currency stabilisation. Theme 2 focuses only on the current account.
● Flows of money into the country are given a positive sign and flows of money out are given a negative sign. It is important to remember that the balance of payments looks at where the money flows.
Current account: component of balance of payments
The current account itself is split into different parts:
● Trade in goods: These are known as visibles because you can physically see them. They are goods that are traded, whether raw materials or finished goods. The difference between visible exports and visible imports is known as the balance of trade.
● Trade in services: These are services traded in or out of the country, known as invisibles. A holiday to Spain by a British family is an invisible import as money leaves the UK and goes to Spain, whilst a Japanese firm buying insurance from a city of London firm is an invisible export as money enters the UK.
Balance of trade in goods and services: component of balance of payments
The balance of trade in goods and services is the balance of trade + balance of invisibles.
● Income and current transfers: Wages, interest, profit or dividends can be repatriated into the country. For example, a Polish person could send the money they make in the UK back home to Poland or a British person could take the profits from their overseas country back to the UK. Current transfers are usually done by governments and are when they transfer money into or out of overseas organisations such as the EU. Income and current transfers can be split into primary and secondary incomes: primary income is the result of loans of the factors of production abroad e.g. interest, profits and dividends (including wages sent to other countries) whilst secondary income is a range of mainly government transfers to overseas organisations, such as the EU.
Current account deficit vs surplus
The current balance = Balance of trade + Balance of invisibles + Net income and current
transfers.
- A current account surplus is where exports are greater than imports, so the current balance is positive.
- A current account deficit is where imports are greater than exports, so the current balance is negative.
Relationship between current account imbalances and other macroeconomic objectives
● Governments tend to have four main objectives: low unemployment, low and stable inflation, economic growth at a similar rate to other economies and a balance of payment equilibrium, including current account balance. However, achieving a balance of payment equilibrium can be affected by achieving other aims.
● High economic growth tends to mean that the current account becomes a deficit as there is increased imports due to increased demand, and it is during times of high unemployment etc. that the current account deficit tends to improve.
● Governments tend to want export led growth, which would cause economic growth, high employment and improve the current account balance; although it could lead to inflation. There have been frequent export initiatives but successive UK governments have been unable to achieve this.
Interconnectedness of economies through international trade
Over time, the world economy has become increasingly interconnected, this is due to four key ways which have led to globalisation:
● The proportion of output of an individual economy which is traded internationally is growing.
● Many more people (or companies) own assets in other countries such as shares, loans or businesses.
● There is increasing migration between countries
● More technology being shared on a faster basis.
International trade has meant countries have become more interdependent so a change in the economic condition of one country will affect another, since the quantity they import or export changes. In theory, all current balances should add up to zero as what one country exports another imports.
