4.1.7 Balance of Payments 1 Flashcards
Balance of payments
a record of all a country’s financial dealings with the rest of the world over the course of a year
Components of the balance of payments
- The current account
- Capital account
- Financial account
- International investment
Components of the current account
- Balance of trade (trade of goods & services)
- Income
- Current transfers
Capital account
records all capital transfers & net acquisitions or disposal of non-produced, non-financial assets
Financial account components
- direct investment
- portfolio investment
- financial derivatives
- reserve assets
Balance of trade
the difference between the value of g/s exported & value of g/s imported
- exports = money into country = a positive entry into the balance of payments - UK has £25 bn deficit
Income
income earned by domestic citizens who own assets overseas minus income earned by foreign citizens who own asset in this country
- includes profits, dividends on investments aborad & interest
Current transfers
money transfers between central govt (who lend & borrow money from each other) or grants, such as those that the UK receives as part of the CAP from the EU
Current account deficit
the value of money leaving the country exceeds the value of money entering the country
Current account surplus
the value of money entering the country exceeds the value of money leaving the country
Financial account
transactions associated with changes of ownership of the UK’s foreign financial assets & liabilities
Direct investment
capital provided to or received from an enterprise, by an investor in another country
Portfolio investment
investments in equities & debt securities
Financial derivatives
any financial instrument the price of which is based upon the value of an underlying asset
- include trade financial futures, warrants & currency & interest
Reserve assets
foreign financial assets that are available to & controlled by the monetary authorities such as the BoE for financing or regulating payments imbalances
- e.g monetary gold, special drawing rights, reserve position in the IMP, foreign exchange held by the Bank
International investment position
the balance sheet of the stock of external assets & liabilities
Why must balance of payments balance?
- If a country has a current account deficit, it must have a surplus on the other elements of the balance of payments. This is because it has to pay for everything it consumes & funds in some ay- to fund a current account deficit, a country must be selling assets to foreign investors
- this might sustainable in the long run since if ppl invest in a country, at some point, they will require a return on their investment & they will cause a deficit on the financial account
Are global imbalances significant?
- since a country’s balance of payments must always balance, any global imbalances are insignificant. However, the Global Financial Crisis of 2008 suggests the persistently large current account deficit may be unsustainable in the long run
Are global imbalances significant? (yes)
- large & persistent deficits can be a problem bc there is need to finance the increasing expenditure on imports, usually through loans from abroad
Are global imbalances significant? (yes) 2
- large & persistent deficits can be a problem bc resources are focused on producing to meet export demand rather than domestic demand so consumer choice & living standard decreases
- imbalances = large currency fluctuations = instability of world
Why might UK be running a persistent deficit on the current account?
- Wages
- Investment
- High consuming spending
- Less competitive
Why might UK be running a persistent deficit on the current account? (wages)
UK firms pay UK workers abroad = outflow of money.
- The outflow to UK workers > inflows to foreign workers in UK
Why might UK be running a persistent deficit on the current account? (investment)
- decrease in direct investment income
Why might UK be running a persistent deficit on the current account? (high consumer spending)
increased deficit, low saving
Why might UK be running a persistent deficit on the current account? (less competitive)
increase wage costs, poor quality = decreased competitiveness
Current account surplus example
- Norway- current account surplus is 15% of GDP
- exporting energy (oil and gas)
Current account surplus example 2
Ireland- current account surplus of 13.9% of GDP
- low corporation tax (12.5%) compared to over 20% in other European countries
