4.1.7 - Balance of payments Flashcards
What is the balance of payments ?
A record of all facial transactions between one country and the rest of the world
Components of the balance of payments
- Current account
- Capital and financial account
What makes up the current account ?
What makes up financial account
FDI and Portfolio investments are similar however FDI buys more than 10% of a company and portfolio investments by less than 10%
Factors affecting the current account
- Exchange rate
- Relative inflation
- Productivity and costs
- Quality
- Growth
- Protectionism
How does exchange rate affect current account ?
- When the pound appreciates, import expenditure will increase and export revenue will decrease . This will decrease or worsen the UK current account.
Import expenditure increases because the stronger pound makes them cheaper for UK consumers, increasing their demand. This means that more money is leaving the UK economy.
Export revenue decreases because the stronger pound makes them more expensive for foreign consumers, decreasing their demand. This means that less money is entering the UK economy. - When the pound depreciates (gets weaker), imports get more expensive and exports get cheaper.
With more expensive imports, UK consumers will buy less, which will decrease import expenditure. There will be less money leaving the UK economy.
With cheaper exports, foreign consumers will buy more, which will increase export revenue. There will be more money entering the UK economy.
Outflows are decreasing and inflows are increasing, so the current account is increasing or improving
How does productivity and cost affect current account ?
How does quality current account ? - This is a long term cause
Higher quality makes exports more internationally competitive. This will help increase export revenue helping to run a current account surplus.
E.g October 2024 Germany ran a current account surplus of 12.6bn USD. This may be due to their high quality vehicles which makes their vehicles more internationally competitive.
Vice versa for Lower quality goods and services
How does economic growth affect the current account ? - This may be a short term cause
- Rapid economic growth raises household income
Households respond by purchasing goods/services with a high-income elasticity of demand (income elastic)
Many of these goods are imported and as imports rise, the balance on the current account worsens
How does relative inflation affect the current account
- A higher inflation rate in one country in comparison to another country would mean that their price level is increasing more than the other country. So good’s and service would be more expensive in that country. This would decrease the demand for exports as more expensive exports make them less internationally competive and it will also cause the demand for imports to rise as cheper goods in other countries will make forging imports more internationally competive.
- This will all lead to a worsening of the current account.
Eval:
- Infaltion doesn’t take into account the starting price of exports and imports.
- Other factors affect the current account.
How does protectionism affect a countries current account ?
- Tarrif increase the price of imports, this will help to reduce the demand for imports and decrease import expenditure and improve the current account.
- Rmeoval of tariff will decrease the price of imports and so the opposite effect will happen
What is the impact of a currrent account deficit on the exchange rate.
- This is because of UK consumers want to import more products. They must buy more of that countries currency, which would require them to sell more of the UK’s currency, increasing the supply of the pound.
- If it is speculated that the currency will continue to depreciate, it is likely that foreign investors storing their money in pounds will sell their pounds in exchange for a currency that is appreciating, further increasing the supply of pounds which will lead to further currency depreciation.
- imports become more expensive which will lead to a lower standard of living and cost push inflation.
Impact of a current account surplus on AD
- Talk about the mulrpie effect as ⬆️ exports = ⬆️ demand for labour (derived demand) = ⬆️incomes = ⬇️unemployment ⬆️consumption.
- Also higher living standards from import expenditure.
Eval : - Exports from facotories may lead to water and air polluton whoch is bad for the enivironment and Chinese health (neg exteralties).
- PPD
What is the impact of a current account defeicit on AD
Eval : it depends on what % the deficit is on a country’s GDP
- Draw a Keynesian’s diagram and how AD decrease when the country is operating at full employment
What are trade imbalances ?
- Significance of trade imbalances for countries running a deficit.
Economic Stability: Persistent imbalances can lead to financial instability, as countries may accumulate unsustainable levels of debt.
- Significance of trade imbalances for countries running a surplus.
What are the measures that can be taken to reduce imbalances on a current account ?
- expenditure switching policies
- expenditure reducing policies
- supply-side policies
What are expenditure switching policies effect on BoP and what points would you use to evaluate them ?
- Involves the use of protectionism (tariffs, quotas), or a devaluation of the currency under a fixed exchange rate mechanism.
- This is would ⬆️ price of imports. So that these is a decreased from imports, and so import expenditure ⬇️ and consumers switch to consumption on domestically produced goods/services. This helps improve a deficit
- ⬇️ interest rates foreign investors storing money in Uk banks will sell them (⬆️ supply) = capital flights = ⬆️ supply for currency. WPIDEC = ⬆️ import price = ⬇️ demand for imports = ⬇️ import expenditure.
Any protectionist policy often leads to retaliation by trading partners. This may consist of reverse tariffs/quotas which will decrease the level of exports. This may offset any improvement to the deficit caused by the policy
What are expenditure reducing policies effect on the BoP and what points would you use to evaluate them ?
- Measures designed to reduce aggregate demand (AD), such as deflationary fiscal policy.
- ⬆️ income tax and⬇️ gov spending (on benefits) = ⬇️ disposable income =⬇️mps = ⬇️ consumption and import expenditure = improved deficit. Likely to be effective’s there is a **high-income elasticity for demand ** (talk about how the Marshall Lerner condition supports this).
- Deflationary fiscal policy also dampens domestic demand which can cause output to fall. When output falls, GDP growth slows and unemployment may increase. Also ⬇️ output = decrease exports so deficit may remain unchanged
What are supply side policies effect on BoP and what points would you use to evaluate them ?
- Policies that aim to improve the quantity/quality of the factors of production thereby raising potential output (draw LRAS shifting right)
- Improve quality and quantity = Makes goods more internationally competitive (e.g Germany). Further more Improve quality and quantity will ⬇️ price = further making goods more internationally competitive. = ⬆️ demand for exports
- They usually involve government spending in the form of subsidies and this always carries an opportunity cost (e.g ⬇️ expenditure on healthcare)
- Time lag (use app to further develop this point as time lag alone is basic) - These policies tend to be long term policies so the benefits may not be seen for some time
Diagram for multiples supply side causing depreciation
- currency depreciates
- If it is speculated that the currency will continue to depreciate, it is likely that foreign investors storing their money in pounds will sell their pounds in exchange for a currency that is appreciating, further increasing the supply of pounds which will lead to further currency depreciation.
- imports become more expensive which will lead to a lower standard of living and cost push inflation.
