4.1.7 Flashcards
what are the components of the balance of payments?
- net trade in goods and services
- net primary and secondary income
define primary income?
net flow of profits, interest and dividends from investments in other countries and net remittance flows from migrant workers.
define secondary income
net flow of transfers- overseas aid, debt relief, military grants …..
define trade balance
net value of exports - net value of imports
define current account
measures the difference between the money and credit going in and out of an economy through exports,imports and income paid on assets both home and abroad
define financial flows
flows of capital across national borders inlcuding debt (bonds), equity (shares),FDI
How long has it been since the UK ran a current account surplus?
20 years (2001)
define financial account
transactions that result in the ownership of financial assets and liabilities
what is within the financial account?
- net FDI
- balace of banking flows (hot money flowing in/out of a country’s commericial banks(
- net balance of portfolio investments (debt and equity)
what percentage of FDI did england hold in 2018 of world FDI?
5%
How is a current account deficit financed?
a cuurent account deficit is an exeternal deficit and mena sthat the UK is a net borrower with the rest of the world. To finance an external deficit, the UK needs to attract net financial inflows on the financial acount. This might be achieved when UK stock market is rising and/or property prices are increasing-both attract portfolio inflows. Or it might happen when relativley high intrest rates attract inflows of hot money into the commercial banking system. Or it might happen when UK businesses sell some of their overseas assets and return the money raised home to UK shareholders. Or it can b financed when overseass investors have an appetitie to purchase new issues of UK government debt in bond market.
financial account surplus
what are the macro effects of a large current count deficit?
- fall in AD since (X-M) is negative- lading to slower GDP growth
- drag on GDP growth might then lead to weaker investment and jobs
- A large external deficit, such as a current account deficit, means a country is importing more than it is exporting. To pay for these imports, there is an increased demand for foreign currencies and a greater supply of the domestic currency in international markets. This imbalance leads to downward pressure on the domestic currency’s value, resulting in depreciation.
- heavy reliance on imports may reflect supply side weaknesses (competitiveness issues, investment gaps, resource allocation)
what are the cyclical causes of a current account deficit?
(short term)
explain how low productivity can lead to current account deficit
labour productivity measurs output per hour worked by person.Relativley low producitivity means that efficency in the UK is below that of other major trading competitor nations. If labour producivity is low, then for a given level of wags- the unit cost of production of production willl be higher. As a result exporting firms with low producitivity may find themslevs at a price and cost disadvantage in oversears markets. This might cause a slowdown in exports as foreign consumers look for relativley cheaper substitutes. And it might also cause a rise in import penetration into domestic economy, as domestic consumers also perfer to buy the cheaper imported goods/ services.
explain how an economic boom can cause an external deficit
an economic boom occurs when demand, real incoms and national output are all rising above trend rates. One effect of this is often a strong rise in consumer spending for goods and services which have a high income elasticity of demand. A large percentage of consumer durables such as new cars and household appliances tend to b imported. Thus a rise in consumer spending (and a reduction in household savings) can cause the volume of imports to rise at a fast pace. If the domestic economy is booming there might be limited spare capacity in general and in export industries in particular. Thus, higher imports and and a slowdown in exports may lead ro a widening of a countries current account.
what are the short term causes of current account deficit?
- fall in value of exports (decline in world price
- boom in consumer spending, increasing demand for imports
- appreciation in exchange rate, export sector becomes less competitive
- economic boom!
short term causes are cyclical in nature
what are the longer term causes of a current account deficit?
- low rates of capital investment: limiting productive capacity and cost competitivness
- price inflation and high costs in comparison to trade partners
- weaknesses in non price competiton such as branding and innovation
- lomg term decline of previosly dominant export sectors (deindustrilaisation in manufacturning)
define expenditure switching prices
policis designed to change th relative prices of imports and exports
what are some examples of expenditure switching policies?
- central bank intervene to lower the external value of currency (managed)
- government subsidies to domestic producers
- import tarrifs designed to increase the price of imported products
- period of internal devaluation (falling domestic price level) to improve cost competition of business
define expenditure reducing policies
contractionary monetary and fiscal polcies designed to lower reall incomes as AD, thereby cutting demand for imports
what are some evaluations to the following expenditure switching policies?
1. depreciation
2. import tarrifs
3. low rate of inflation (deflation)
- risk of cost push inflation- erodes competitive boost + fall incomes/standard of living
- risk of retaliation from other countries
- risks from deflation in general eg: lowr investment
no gurante that depreciation wil imporve country external trade J curve
what are some expenditure reducing policies?
- rise in burden of direct taxes
- cuts in gvernment spending on welfare
- cuts in government spedning on public services
analysis + evaluation for increase in income tax as method of expenditure reducing policy
reduced real disposable incomes causing demand for imports to fall
ev: cuts in living standards and damages incentives to work in labour market. imports may be income inelastic
analysis + evaluation for cuts in real level of government spending
lowers AD, firms may look to export to make fuller use of their spare capacity
ev: damage to short term economic growth, could impact plannned business investment, worsening trade balance in long term.
what is the difference between cyclical and structural causes of a trade deficit?
- cyclical: economoy is experienceing a boom, rising real incomes and consumer spedning and a falling saving ratio can lead to a surge in import demand which can cause an increase in the size of trade deficit
- structural : supply side weakenesss in an economy such as low capital investmnet, low producitivity &r research and business not operating at the cutting edge of innovation
what supply side polcies can help reduce current account dficit?
attempt to improve cost and price competitvness of export businesses
- infrastructure projects eg: improving transport networks, telecoms to increases supply side capacity and productive efficency, lower costs of production, more firms can export now
- incenties to promote enterprise/ start ups/ new export businesses
- privatisation/degregulation to increase producity & efficecny
- investment in ducation to imrpve a country’s human capital (even inwards migration)
what is the J curve effect ?
in the short run a currency depreciation may not necessarily improve the current account balanc. This is ncause the price elasticities of demans for exports and imports are likley to be inelastic in the short term. Initially th quantity of imports bought will remain steady bcuase many contracst for imported goods are already signed. It takes times for export businesses to increase thir sales following a fall in prices. Earnings from selling exports may be insufficent to compensate for the higher total spending on imports. The trade balance may therfor initially worsen.
what is th marshall-lerner condition
a depreciation/ devaluation of the exchange rate will lead to a net improvement in the trad balance provided that the sum of the PED for exports +PED for imports >1
what are the main causes of current account surpluses?
- country building stong competitive advantage in a range of industries and markets leading to fast export growth
- persistent surplus if savings (S) over investments (I) for households, firms and government, which means dmand for imports is weaker
- high world prices for exports of commodities
- strong net inflows of investment income from assets owned overseas or when inflows of remittancs from peoople living and working in other countries is a high % of GDP
what are the macro effects of current account surplus?
a surplus on the current account would allow a country to run deficit on th financial account of the balance of payments. For exampl, surplus foreign currecny can b used to fund investment in assets located overseas. Some current account surplus countries have large sovereign wealth funds. Current account surplus countries with floating currencies nearly always have a stronger exchange rate since high export sales leads to an increase in demand for a nation’s currency.
what are sovereign wealth funds?
state-owned investment funds, generated from the country’s natural resources or foreign currency reserves.
Norway has the world’s largest sovereign wealth fund.
