2.1.4 - Balance of payments Flashcards
What is the balance of payments ?
- The Balance of Payments (BoP) for a country is a record of all the financial transactions that occur between it and the rest of the world
● The current account should balance with the capital/financial account and be equal to zero.
o If the current account
balance is positive, then
the capital/financial
account balance is
negative (and vice
versa)
Money flowing into the country is recorded in the relevant account as a credit (+) and money flowing out as a debit (-).
What is the balance of payments made up of ?
-
Components:
o The current account: all transactions related to goods/services along with payments related to the transfer of income.
o The financial & capital account: all transactions related to savings, investment and currency stabilisation.
What are the components of the current account ?
● Trade in goods – This is the value of goods going out of the country (exports of goods) minus the value of goods coming into the country (imports of goods).
● Trade in services – This is the value of services going out of the country (exports in services) minus the value of services coming into the country (imports in services).
Income – Interest, profits and dividends(including wages sent to other countries). the income sent to foreign countries from workers working in the domestic country.
Transfers – Money is transferred abroad without getting any goods or services back in exchange. This is often in the form of remittancesThis includes payments to overseas organisations, such as EU fees or aid contribution.
Current Account deficit
the value of the outflows is greater than the value of the inflows
Usually occurs when the
o imports greater than exports
How to reduce current account deficit:link
Current Account surplus
the value of the inflows is greater than the value of the outflows
Usually occurs when
o imports less than exports
What are the Macroeconomic objectives
- Low unemployment
- Low inflation
- sustainable economic growth
- balance of payments
Blurt everything you know about The Relationship Between the Current Account Imbalances & Macroeconomic Objectives.
● Impact on Exchange Rates: A persistent current account deficit may lead to a depreciation of the country’s currency, making exports more competitive and imports more expensive. This can help correct the deficit.
● Impact on Economic Growth: A surplus can lead to higher savings and investment, potentially boosting economic growth. However, a persistent deficit may lead to unsustainable borrowing.
● Impact on Employment: A trade surplus may support job creation in export-oriented industries, while a deficit can lead to job losses in import-competing sectors.
●Impact on Inflation: A depreciating currency (due to a deficit) can lead to imported inflation, affecting the domestic price level.
interconnectedness of economies
What is the impact of an increase in exports on the UK Current Account
It increases due to an increase in injections. (current account appears positive transaction).
What is the impact of an increase in imports on the UK Current Account
It decreases due to an increase in withdrawals.(current account appears negative transaction).
Investment income earned by a UK investor abroad will appear in the current account as ?
Investment income earned by a UK investor abroad will appear in the current account as a positive transaction because money is entering the UK. This will increase the current account.
What are remittances
Sending over money abroad (back to home country) to your family.
e.g mummy sending money to aunty buky in nija.
Transfers + and -
Sending money abroad = -
Receiving money from abroad = +
What is current account equilibrium
Total inflows = Total outflows
( 0 )
Explain what will happen in the long run if the UK remains in a current account deficit.
- If the uk remains in a current account deficit, the money will come straight back into the uk economy as Investments so thefinancial and current account will balance this out by being in surplus.
- However when money comes into the uk economy as investments. Its because foreign investors are investing in UK assets buying up UK properties and share.
- So in the future when the proprieties are rented out and the businesses start making profits the earnings all go back into the foreign investors abroad.
- Large leakage in the circular flow of income
(link)[https://app.uplearn.co.uk/learn/macroeconomics-1/balance-of-payments/current-account-macroeconomic-objective-video]
How does exchange rates effect (weaker pound) Balance of payments ?
WPIDEC (weaker pound imports deer exports cheaper) : A weaker pound means that one pound can buy fewer units of foreign currency. This change in exchange rates makes British goods and services cheaper for foreign buyers, while imports become more expensive for UK consumers. So we will import less and export more
How does exchange rates effect (stronger pound) Balance of payments ?
SPICED (strong pound imports cheaper exports deer) :
Imports : A stronger pound makes imports cheaper. British consumers and businesses can buy foreign goods, raw materials, and services at lower prices. This can lead to lower production costs and cheaper products for consumers.
Exports: On the flip side, a stronger pound makes UK goods and services more expensive for foreign buyers. This can reduce demand for British exports, making them less competitive in international markets. Exporters may struggle with reduced sales, potentially impacting jobs and economic growth in export-dependent industries.
How does an appreciation of the pound effect the current account.
When the pound appreciates, import expenditure will increase and export revenue will decrease. This will decrease the UK current account.
Explanation :
Import expenditure increases because the stronger pound makes them cheaper for UK consumers, increasing their demand. This means that more money is leaving the UK economy.Export revenue decreases because the stronger pound makes them more expensive for foreign consumers, decreasing their demand. This means that less money is entering the UK economy.
Outflows will increase and inflows will decrease, so the current account will decrease.
How does a depreciation of the pound effect the current account.
When the pound depreciates, import expenditure will decrease and export revenue will increase. This will increase the UK current account
Explanation : With more expensive imports, UK consumers will buy less, which will decrease import expenditure. There will be less money leaving the UK economy.With cheaper exports, foreign consumers will buy more, which will increase export revenue. There will be more money entering the UK economy.Outflows are decreasing and inflows are increasing, so the current account is increasing.
Factors affecting the current account.
- Exchange rate
- Relative Inflation rate
- Quality
- Production costs in that country
- Increase in income
What is meant when they say, when the exchange rate decreases or fall in the exchange rate.
The country’s currency has depreciated
How does relative inflation affect balance of payments
- If one country has a higher inflation rate than another. Then the country will the higher inflation rate might have higher prices for their goods and services. (As inflation doesn’t take into account the begging price)
- As a result they will purchase the same goods and services from the other country where it’s sold for cheaper.
- So demand that country’s goods and services will sell more goods and services. Increasing their revenue from exports
E.g buying stuff from Nigeria where its cheaper.
Watch here - (link)[https://web.uplearn.co.uk/learn/macroeconomics-1/balance-of-payments/relative-inflation-video]
How does lower production cost effect current accounts
If a country has lower production costs, its export prices will decrease. This will increase foreign consumers’ demand for its exports, these goods become more competitive in the international market because they are cheaper compared to those from other countries. which will increase its export revenue. + trades in goods and services. This will increase its current account.
e.g indian labour is cheap
vice visa for higher production cost
How does quality effect current account.
Better quality makes your goods more internationally competitive as the goods and services are more reliable, durable, which will help create a strong brand reputation In the International market e.g Germany and their cars.
This increases demand for their goods, so their export will increase, which will help maintain a trade surplus. contributing positively to their current accounts.
