3.3 Balance of payments Flashcards
What is the role of the balance of payments?
The balance of payments of a country us ‘a record (usually for a year) of all transactions between the residents of the country and the residents of all other countries’
What are the accounts on the balance of payments?
- Current account
- Captial account
- Financial account
What does the current account represent?
- Balance of trade in goods
- Balance of trade in services
- Factor rewards/income (wages, rents, interest, profit)
- Current transfers (e.g. foreign aid)
[it is the largest]
What does the capital account represent?
- Net capital transfers (e.g. debt forgiveness)
- Non-produced, non-financial assets (e.g. intellectual property, fishing rights)
[it is the smallest]
What does the financial account represent?
- (FDI) Direct investment (physical capital e.g. factories)
- Portfolio investment (e.g. stocks & bonds)
- Reserve assets (e.g. foreign currency)
What is credit?
Money/value “paid in” on a country’s account
What is debit?
Money/value “paid out” on a country’s account.
If there is a debit on the current account, how does this affect the currency?
It would cause a surplus of the currency, which would cause depreciation.
If there is a credit on the current account, how does this affect the currency?
It would cause a shortage of the currency, which would cause appreciation.
If credits > debits, how do we describe the current account?
There is a current account surplus.
If credits = debits, how do we describe the current account?
There is a balance of the current account.
What must equal on the balance of payments?
Current account + capital account + financial account + net errors and omissions = 0
How does the balance of payments correct in a free-floating exchange rate system?
Automatically (through market forces)
How does the balance of payments correct in a fixed exchange rate system?
Requires intervention by the government and/or central bank.
How are the current account and financial account related?
A current account deficit balances with a financial account surplus.
E.g. Appreciation that has caused a current account deficit (X-M), might cause direct investment to increase.