4.2.6.3 - The Balance of Payments Flashcards
What is the balance of payments?
A record of all the currency flows into and out of a country in a particular time period.
What is the current account?
Measures all the currency flows into and out of a country in a particular time period in payment for exports and imports of goods and services, together with primary and secondary income flows.
What is the financial account?
The part of the BoP that records capital flows into and out of the economy.
What is the balance of primary income?
Inward primary income flows comprising both inward-income flowing into the economy in the current year generated by UK-owned capital assets located overseas, and outward primary income flows comprising income flowing out of the economy in the current year generated by overseas-owned capital assets located in the UK.
What is the balance of secondary income?
Current transfers, international aid, and transfers between the UK and EU, flowing into or out of the UK economy in a particular year.
What is the current account deficit and surplus?
Currency outflows in the current account exceed currency inflows and vice versa, respectively.
Why does the UK run a trade deficit?
They consistently import more than they export.
Why may the current account deficit cause an issue in the future?
If the UK is unable to finance their current account deficit due to investors losing confidence in the UK, then there will be a dramatic fall in living standards.
What is the balance of trade in goods?
The section of the current account that measures payments for exports and imports of goods.
What is the balance of trade in services?
Part of the current account which measures the difference between the payments for the exports of services and the payments for the imports of services.
Where does the UK have a competitive advantage over many other countries?
Service-sector industries (financial, insurance, ICT services, etc.).
What are primary income flows mostly made up of?
Investment income generated from profits, dividends, and interest payments flowing between countries.
How does profit income return to the UK?
Income generated from overseas investment flows back to the parent company and its UK shareholders. The investment itself is an outward capital flow, but the income it generates is current income.
Why does the UK have a negative secondary income balance?
Net contributions to the EU budget, overseas aid, and the cost of maintaining armed forces (e.g., Afghanistan, Ukraine, etc.).
How do you make inward investment income?
Through outward capital flows.
What does direct overseas investment mean?
The acquisition of real productive assets (e.g., factories, oil refineries, etc.).
What is foreign direct investment?
Investment in capital assets in a foreign country by a business with HQ in another country.
What is portfolio investment?
The purchase of one country’s securities by the residents or financial institutions of another country.
Why did investment fall after the credit crunch in 2007?
Very low consumer and business confidence in the economy.
How does ‘hot money’ move?
If the owners of funds believe the value of a currency will fall or rise, they can move money into that currency expecting short-term speculative gains.
Why is ‘hot money’ an issue?
Large-scale flows of money destabilize exchange rates as excess supply and demand between currencies cause exchange rates to fluctuate significantly.
Explain what happens when the graph moves from AD1 to AD2?
At point X, the economy is in deep recession. Increasing AD causes real output to rise to Y2, although at the cost of some inflation as the price level rises to P2.
Explain what happens when the graph moves beyond Y3?
As the economy reaches the LRAS curve, export demand becomes inflationary rather than reflationary, causing the price level to rise drastically.
Why is the LRAS likely to shift right in the case of exports increasing?
If foreign demand for exports is due to favorable supply-side conditions in the domestic economy, the LRAS curve shifts right as the productive capacity of the economy increases.
What is export-led growth?
Short-run economic growth due to an increase in exports.
Do current account deficits pose problems?
In the short run, no. In the long run, they may indicate a fundamental disequilibrium in the economy, leading to a decline in domestic industries due to international competition.
Do current account surpluses pose problems?
They can. One country’s surplus is another’s deficit, and a surplus can be inflationary.
How does one country’s surplus being another’s deficit pose a problem?
On a global scale, the BoP is zero. If surplus countries do not reduce their surpluses, deficit countries cannot reduce their deficits. This may lead to protectionist measures, and in extreme cases, a world recession triggered by a collapse in global trade.
How can a balance of payments surplus be inflationary?
A balance of payments surplus injects AD into the circular flow of income, raising national income. If the economy is near full capacity, demand-pull inflation occurs.
What are the three factors that influence the current account balance of a country?
Productivity, inflation, exchange rate.
How does inflation influence the current account balance of a country?
If a country’s inflation rate is lower than its trading partners, its exports become more price competitive, and imports become less price competitive.
What are the main policies to reduce a BoP deficit (in the short run)?
Deflation, direct controls, devaluation.
How does deflation reduce the BoP deficit?
Contractionary fiscal or monetary policy reduces AD, leading to lower spending on imports.
How do direct controls reduce the BoP deficit?
Quotas or embargoes on imports directly limit spending on foreign goods, forcing people to buy domestic products.
How does devaluation reduce the BoP deficit?
Reducing the currency’s external value makes imports more expensive and exports cheaper, encouraging domestic production and reducing import dependency.
Why are direct controls weakened in the world economy?
The WTO and other free trade organizations limit individual countries’ ability to impose import controls unilaterally.
Why do price elasticities of demand for exports and imports affect the effectiveness of a fall in the exchange rate?
If both exports and imports are highly price elastic, a fall in the exchange rate can reduce a current account deficit. Higher prices of imports discourage purchases, while lower export prices increase foreign demand.
What is the Marshall-Lerner condition?
If the sum of the price elasticities of demand for exports and imports is greater than one, a fall in the exchange rate will reduce a deficit, and a rise will reduce a surplus. (PEDX + PEDM > 1)
Why does the Marshall-Lerner condition hold?
If export and import demand are inelastic, depreciation causes total export revenue to fall and total import expenditure to rise, worsening the current account deficit. If demand is elastic, the deficit decreases.
What happens to the Marshall-Lerner condition in the short run?
Demand for imports and exports is inelastic in the short run because it takes time for consumers to adjust. As a result, the BoP worsens before improving.
What is the only way to improve a BoP in the long run?
Effective supply-side policies and supply-side improvements by firms within the economy.
How can the UK ensure they increase their exports?
By improving price competitiveness and quality competitiveness.
What are the main issues with consumption-led growth?
1) A significant portion of consumer spending goes toward imports. 2) It is unsustainable as speculative bubbles can collapse. 3) It may cause inflation due to rising AD.
How can the government reduce a BoP surplus?
Reflation, removal of import controls, revaluation.
