4.3.3 Balance of Payments and Exchange Rates Flashcards
What is the Balance of Payments?
A record of all financial transactions between one country and the rest of the world
Respectively, what are inflows and outflows of currency to/from the balance of payments referred to as?
Positive and Negative Entry
What is the Current Account?
Where payments for the purchase and sale of goods and services are recorded
What is the Current Account comprised of?
- Trade in Goods Balance
- Trade in Services Balance
- Investment Income Balance
- Current Transfers
What is the ‘investment income balance’ in the Current Account?
Income from assets owned overseas - income paid to foreign investments in the UK
What is the Capital and Financial Account?
Where flows of money associated with saving, investment, speculation and currency stabilisation are recorded.
What takes place in the Capital Account?
Financial capital that enters or leaves the country along with immigrants/emigrants who take it with them
What is recorded in the Financial Account ?
- Foreign Direct Investment
- Portfolio Investment
- ‘Other’ Investments
What is Foreign Direct Investment?
Flows of money to purchase a controlling interest in a firm (at least 10% of shares)
What is portfolio investment
Flows of money to purchase foreign shares which amount to less than 10% of overall shares/voting power
What are ‘other investments’ in the financial account apart from FDI and Portfolio investment?
- Trade Credit
- Loans
- Purchases of Currency
- Bank Deposits
What are the reasons for international capital flow?
- Currency Speculation
- Loans by Banks to finance loans to households
- Profitability of short term loans to economic agents in other countries
What are the economic advantages of International Capital Flows?
- Facilitates growth in world trade by financing it
- Provides Capital for firms that cannot get finance for it domestically
- Leads to sharing of technology between nations. FDI is the best way for LEDCs to get modern tech
What are the disadvantages of International Capital Flows?
- 2008 Financial crisis showed vulnerability of global financial system to problems
- Threats to national security if other countries own significant industries in UK
- Encourages firms/countries to overborrow increasing risk of financial crisis
What are the causes of Surpluses and Deficits in the Current Account?
- Natural Resources
- Underlying Competitiveness
- Exchange Rates
- Inflation
- Investment and long term economic growth
- Spending by consumers and governments
How are natural resources a cause of current account imbalance?
Some countries have abundant natural resources relative to population size, so they have a lot to export but not a lot of people importing
How is underlying competitiveness a cause of current account imbalance?
Good international competitiveness means more exports so more surplus.
Bad competitiveness means less exports so more deficit.
How are exchange rates a cause of current account imbalance?
Some countries manipulate their exchange rates to stay low to keep exports cheap, leading to surplus. Other keeps exchange rates high in order to have cheap imports but leads to deficit
How does inflation affect current account imbalances?
high inflation rates damage price competitiveness, decreasing exports and leading to deficit.
Lower relative inflation improve price competitiveness and lead to increased imports and lead to surplus
How are investments and long term economic growths factors to determine current account imbalances?
- Large amounts of FDI flowing into a country means deficit
- New exporters of capital typically mean surplus
How is spending by consumers and governments link to current account imbalances?
-Too much spending linked to deficits because of the need to borrow internationally to finance
