4.1.7 - Balance Of Payments Flashcards
What Is The Balance Of Payments?
(4 Points)
~ Record of all financial transactions that occur between it and the rest of the world.
~ Has to balance. E.g. If there is a current account deficit, there must be a financial and capital account surplus. Vice versa.
~ Money flowing into a country is a credit (+).
~ Money flowing out of a country is a debit (-).
What Are The 2 Components Of The Balance Of Payments?
~ Current account.
~ Financial and capital account.
Describe The Current Account
(3 Points)
~ Measures trade in GOODS and SERVICES via imports and exports. (Trade balance)
~ Measures flows of INCOME. (Income balance) E.g. Remittances -> Uk worker goes abroad and works there, bringing the income back will be a credit in the current account.
~ Measures TRANSFERS -> Government level spending between countries. (Income balance) E.g. Aid to developing countries.
What Is Meant By A Current Account ‘Deficit’
(4 Points)
~ Buying more from the rest of the world, then it’s selling to the rest of the world.
~ More money leaving the country, than entering through financial transactions.
~ Cannot be sustained in the LR.
~ Money to fund this tends to come from surpluses in the financial account.
What Is Meant By A Current Account ‘Surplus’
(4 Points)
~ Selling more to the rest of the world, than its buying from the rest of the world.
~ More money entering the country, then leaving through financial transactions.
~ Sitting on a lot of excess cash, investing it into countries where there is a current account deficit.
~ Meaning this country will have a financial account deficit.
Describe The Capital Account
(2 Points)
~ Records small capital flows between countries and is relatively unimportant.
~ Measures debt forgiveness, transfer of financial assets by migrants, sales of tangible assets.
Describe The Financial Account
(4 Points)
~ Records the flow of all transactions associated with changes of ownership of the UK’s foreign financial assets and liabilities.
Looks At:
~ Portfolio investment transactions.
~ Foreign direct investment (FDI).
~ Reserve assets.
Describe ‘Portfolio Investment’ Of The Financial Account
(2 Points)
~ Buying and selling of financial assets.
~ E.g. Bonds and shares.
~ E.g. USA buys UK government bonds, recorded as a credit for the UK as it is inflows into the financial account.
Describe ‘FDI’ Of The Financial Account
Flow of money to purchase part of a foreign firm.
Describe ‘Reserve Assets’ Of The Financial Account
(2 Points)
~ Are assets controlled by the central bank.
~ E.g. Currency and gold.
What Are Causes Of A Current Account Deficit On The Demand Side?
(3 Points)
~ Strong domestic growth.
~ Recession overseas.
~ Strong exchange Rates.
What Are Causes Of A Current Account Deficit On The Supply Side?
(4 Points)
~ Low investment and productivity.
~ High relative inflation and unit labour costs.
~ Poor quality of goods.
~ Depletion of resources.
Describe ‘Strong Domestic Growth’ As A Cause Of A Current Account Deficit On The Demand Side
(4 Points)
~ Incomes would be high, people are more willing to buy imports.
~ Imports spending increase.
~ More money leaving the country increases.
~ Balance on the current account worsens.
Describe ‘Recession Overseas’ As A Cause Of A Current Account Deficit On The Demand Side
(4 Points)
~ Incomes abroad begin to fall.
~ Demand for exports reduce.
~ Less money coming into the country.
~ Balance on the current account worsens.
Describe ‘Strong Exchange Rate’ As A Cause Of A Current Account Deficit On The Demand Side
(4 Points)
~ Imports cheaper, exports dearer.
~ Foreign investors look for substitute products at a lower price.
~ Demand for exports reduce.
~ Balance on the current account worsens.
What Are The Consequences Of A Current Account Deficit?
(2 Points)
~ Lower AD, due to net exports decreasing -> causes decrease in growth and rising unemployment.
~ Debt burdens, due to borrowing from other countries to finance the deficit -> causes investors losing confidence.
What Are Causes Of A Current Account Surplus On The Demand Side?
(3 Points)
~ High incomes abroad, increasing demand for exports.
~ Low incomes at home, reduce demand for imports.
~ Weak exchange rate, WIDEC.
What Are Causes Of A Current Account Surplus On The Supply Side?
(5 Points)
~ Low relative inflation, exports become more competitive.
~ Low unit labour costs.
~ High productivity.
~ Strong investment at home.
~ Gains in comparative advantage.
What Are The Consequences Of A Current Account Surplus?
(2 Points)
~ AD can increase.
~ Growth increases.
What Are Measures To Reduce Imbalances On The Current Account?
(3 Points)
~ Expenditure reducing policies.
~ Expenditure switching policies.
~ Supply-side policies.
Describe Expenditure Reducing Policies
(3 Points)
~ Reduces the amount of spending on imports.
~ Work by reducing AD and incomes and the MPM.
~ Contractionary monetary and fiscal policies can be used.
What Are The Consequences of Using Expenditure Reducing Policies?
Conflicts of macro objectives -> growth reduces, unemployment increases.
Describe Expenditure Switching Policies
(3 Points)
~ Using protectionist policies, to reduce domestic spending on imports of certain items.
~ Or using a weaker exchange rate, WPIDEC.
~ Used to switch spending towards domestic goods and services.
What Are The Consequences of Using Expenditure Switching Policies?
(3 Points)
~ Retaliation, can worsen current account further.
~ Can break WTO rules, leads to heavy fines.
~ Can be inflationary, increasing the price of exports.
