2.1.4 Balance Of Payments Flashcards
The balance of payments
a record of all financial dealings over a period of time between economic agents of one country and all other countries
Imports
when goods / services come in , so money goes out .
Exports
when money comes in , so the good / service goes out
Flows of money
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 .
What are the components of the balance of payments?
- The current account
- The capital account
- The financial account
The current account
The current account records payments for trade in goods and services plus net flows of primary and secondary income . This is not the government budget balance .
What four balances does the current account consist of?
Net balance of trade in goods, Net balance of trade in services, Net primary income, Net secondary income
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 .
Income and current transfers
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 .
Primary income
Primary income measures the monetary flows generated from the owning of cross - border financial assets , known as investment income . It represents the yields ( returns ) from UK investments abroad and that of foreign - owned investment in the UK . Primary income also includes pay for cross - border workers such as migrants .
Which income flows appear in primary income ?
Income from direct investments includes profits, dividends, and interest earned by residents from foreign companies. Income from portfolio investments includes dividends and interest earned from foreign securities. Compensation of employees includes wages, salaries, and other compensation earned by foreign workers and residents working abroad. Taxes on income and wealth include taxes paid to foreign governments and domestic residents.
Secondary income
Secondary income in the context of the balance of payments is “ current transfers between residents and non - residents “ - Examples of secondary income transfers include foreign aid , and contributions to international organisations such as the United Nations and the European Union- which the UK has now left .
Which income flows appear in secondary income?
- Remittances, foreign workers’ money sent home, are typically categorized as a credit item in the current account, positively contributing to it. In lower-income countries, remittances can offset trade deficits and achieve or maintain a current account surplus.
- Foreign aid grants, concessional loans, and other assistance also contribute to development and humanitarian goals.
- Diaspora contributions, made by a country’s diaspora to support projects or family members
- Payments to international institutions, such as the UK’s former contributions to the EU budget
The capital account
reflects transactions in fixed assets and is relatively small ; it refers mainly to transactions involving migrants
What does the capital account include?
Capital transfers involve the transfer of assets without any exchange of economic value , such as debt forgiveness , gifts , and inheritance . These transfers can be between governments , institutions , or individuals .
Non-produced and non-financial assets: includes the sale and purchase of non-financial assets like patents , copyrights , and licenses , as well as the transfer of natural resources and land ownership between countries .
The financial account
includes transactions that result in a change of ownership of financial assets and liabilities between a country’s residents and non - residents
What does the financial account include?
- Net balance of foreign direct investment ( FDI )
- Net balance of portfolio investment flows ( inflows / outflows of debt and equity )
- Balance of banking flows ( such as hot money flowing in / out of a country’s commercial banks )
- Changes to the value of a country’s reserves of gold and foreign currency
How does the ‘net errors and omissions’ component work?
Overall , the balance of payments must always be zero , as in some way or other we have to pay for all we consume , and receive payment for all we sell . However , because data can never be entirely accurate , the accounts also incorporate a ‘ net errors and omissions ‘ item , which ensures that everything balances at the end of the day . What this really means is that any deficit in the current and capital accounts will always be balanced by a surplus on the financial account . If British residents buy more goods and services than they sell ( i.e. if there is a current account deficit ) , then they must pay for them by selling financial assets or foreign exchange ( i.e. there must be a financial account surplus ) .
Define net errors and omissions
Net errors and omissions reflect the imbalances resulting from imperfections in source data and compilation of the balance of payments accounts . They are needed to ensure that accounts in a country’s balance of payments statement always sum to zero .
current account surplus
where exports are greater than imports , so the current balance is positive .
current account deficit
where imports are greater than exports so the current balance is negative
The UK’s current account
The UK government aims to achieve a balanced current account. Since 1985, it has run a deficit. Export-led growth could make it positive, but it’s unlikely in the short term. As incomes and wealth rise, imports increase, pushing the balance toward a deficit. Consumers enjoy the variety of goods and services abroad.
What are the main macroeconomic objectives?
- Economic growth
- Low unemployment
- Low & stable rate of inflation
- BoP equilibrium on current account
- Balanced government budget
- Protection of environment
- Greater income equality
What does trade-off mean in terms of macroeconomic objectives?
Setting policies to target one objective may complicate the possibility of achieving other objectives. There is a trade - off.
How does a current account deficit impact AD?
If the current Account is running a deficit , this has a negative impact on aggregate demand ( AD ). Net exports are a component of AD. If net exports are negative , then AD decreases.
How can a current account deficit be corrected?
To correct the current account deficit , the government could raise tariffs. This would likely decrease imports bought by households. Firms that rely on imports for raw materials used in production would now face higher costs of production. These higher costs are likely to be passed on to consumers in the form of higher prices. Reducing the current account deficit has come at the expense of increased inflation in the economy ; there has been a trade-off.
How does economic growth affect the current account?
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 .
Why do governments want export-led growth?
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 .
What has 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 is being shared on a faster basis .
international trade
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 .
Hot money
capital which is frequently transferred between financial institutions in an attempt to maximize interest or capital gain.
