4.1.7 Balance of payments Flashcards
what is the balance of payments made up of?
- the current account
- the capital account
- the financial account
what is the current account?
- net balance of trade in goods
- net balance of trade in services
- net primary income, profits, interest and dividends from investments in other countries(includes interest, profits, dividends and migrant remittances)
- net secondary income (transfers i.e. contributions to EU, military aid, overseas aid)
what is the capital account?
- small element
- sale/transfer of transferable contracts eg copyrights
- debt cancellation/forgiveness
- capital transfers of ownership of fixed assets
what is the financial account?
outlines the net increases and decreases in ownership of a country’s assets
what is FDI (foreign direct investment)?
investment from one country into another (normally by companies rather than governments) that
involves establishing operations or acquiring tangible assets, including stakes in other businesses
- inward investment is a positive for the UK accounts
- outward investment is a negative for the UK financial account of the balance of payments (UK business investing in US)
causes of deficits on the current accounts?
- poor price and non-price competitiveness
- Strong exchange rate affecting demand for exports and imports
- recession in one or more major trade partner countries
- volatile global prices
impact from a current account deficit?
- loss of AD causes weaker real GDP growth ➡️ reduced living standards and rising unemployment
- currency to depreciate, ➡️ higher cost-push inflation
- if choose to borrow money ➡️ increase in external debt carries risks especially if interest rates rise
- loss of investor confidence, ➡️ capital flight and a possible currency/balance of payments crisis
the main causes of a current account surplus?
- large and persistent surplus of savings (S) over investment (I) for households, firms and the government
- export surplus may be the result of high world prices for exports of commodities such as oil and gas
- large positive gap between exports and imports, when net income balance and net transfers are small
➡️strong exchange rate as a result
measures to reduce a country’s imbalance on the current account?
- expenditure switching policies
- expenditure reducing policies
- supply side policies
what are expenditure switching policies?
- Protectionism
- tarrifs, quotas domestic subsidies - Weak exchange rate (less spent on imports)
- decrease interest rates
- increase money supply
what do expenditure switching policies do?
- reduces relative price of exports &
makes imports more expensive - makes domestic prices more competitive
- keeps general price level under control
➡️ risk of cost plus inflation, retaliation from other countries and WTO rules
what do expenditure reducing policies do?
- less spending on imports
- reduces AD + incomes to reduce the marginal propensity to import
➡️ contractionary monetary + fiscal policy (increase interest rates and reduce govt spending)
➡️ issues of conflicting objectives, confidence of buinsses and consumers may be too high, level of the output gap
what does the J curve show?
the possible time lags between a falling
(depreciating) currency and an improved trade balance
- initially the quantity of imports bought will remain steady
➡️ balance of trade will initially worsen
- providing that the price elasticity of demand for imports and exports is greater than one, then the trade
balance will improve over time
whats the the Marshall-Lerner condition?
that a depreciation of the exchange rate will lead to a net improvement in the trade balance provided that the sum of the price elasticity of demand for exports and imports >1
what is a current account surplus?
positive current account balances, meaning that a country has more exports than imports of goods and services
