4.6 Balance Of Payments Flashcards
What is the balance of payments
A record for all transactions between residents of the country and the residents of all other counties
What is a deficit and a surplus in BOP
Surplus in an account occurs when balance has a positive value, meaning that credits are lager than debits
Deficit in an account occurs whenever a balance has a negative value, meaning that debits are larger then credits
What are credits
All payments received from other countries
What are debits
All payments made to other countries
Components of BOP
Current account
Capital account
Financial account
Elements of the current account (4)
Balance of trade in goods - exports are a credit ; imports are a debit
Balance of trade in services - tourism to a country is a credit ; tourism to another country is a debit
Income - income made from abroad sent back to country is a credit - income sent abroad is a debit
Current transfer - money sent home to relatives is a debit; money received from abroad is credit
What does a deficit mean for the current account
There is an excess supply of the currency in the foreign exchange market
Components of capital accounts
Capital transfers - inflows minus outflows for things such as debt forgiveness, investment grants etc
Transaction in non-produced, non-financial assets - purchase or use of natural resources that have not been produced
What does a surplus in the capital account suggest
There is an excess demand of the currency in the foreign exchange market
Components of the financial account
FDI - inflow of FDI, credit ; outflow of FDI, debit
Portfolio investment - inflows for purchase of stocks and bonds, credit ; outflow for purchase, debit
Reserve assets - selling currency to purchase domestic currency, is credit ; buying currency by selling domestic currency, is debit
Official borrowing - inflow of funds from governments abroad, is credit ; lending to other countries, is debit
Interdependence between accounts what must they all sum up to
Zero; sum of all credits always balance with the sum of all debits
Relationship between current and financial account
A current account deficit means country consumes more then it produce ; therefore paying for extra output consumed through a financial account surplus
Relationship between current account and exchange rates
deficit in current account implies excess supply of currency due to decrease demand for exports — downward pressure on ER - deprecation
surplus in the current account , implies increased demand for exports - market forces create upward pressure on ER (appreciation)
Graph for relationship between current account DEFICIT and exchange rates
Graph for relationship between current account SURPLUS and exchange rates
Relationship between financial account and ER
- country with financial surplus experiences high inflation - central bank purse contraction are monetary policy by increasing interest rates
- Attract inflow of financial capital and additional credits in the financial account correspond to increased currency demand
- Fall in currency supply as domestic investors now prefer financial investments in the domestic market
- More credits with fewer debts result in excess credits - excess of current demand over supply - appreciation of the currency of the county
Implications of persistent current account deficits
• depreciating exchange rate
• Need for higher interest rates to attract foreign financial investments
• Foreign ownership of domestic assets
• Increasing levels of debt
• Cost of paying interests on loans
• Fewer imports of needed capital goods
• Poor international credit ratings
• Lower economic growth
• Lower standard of living in future
Policies to correct persistent current account deficits
• expenditure reducing policies
• expenditure switching policies
• supply side policies
Explain expenditure reducing policies
- contractionary fiscal and monetary policies reduce AD - lower demand for imports
- combination of fewer imports and more experts may work to reduce the current account deficit
- however may create a recession - also risk of that high interest rates leads to current appreciation - discourage exports and encourage imports - canceling out beneficial effects
Explain expenditure switching policies
attempt to switch consumption away from imported goods and towards domestically produced goods
Does this through:
- Depreciation of the currency – makes imports less attractive
- Trade protection
Explain supply side policies
- increase competitiveness
- lower costs of production for firms
- make firms more competitive in global market
- long run - lower rates of inflation - increase exports - addressing the current account deficit
- a disadvantage is that they take a long time to make effects felt
What does the Marshall-learner condition state
if sum of PEDs for imports and exports is >1 then a depreciation will improve the trade balance — e.x if PED for imports greater than one - value for imports falls - positive effect on trade balance
If sum of PED is <1, depreciation will worsen trade balance
Consequences of persistent current account surplus
low domestic consumption
insufficient domestic investment
appreciation of the domestic currency
inflation
reduced export competitiveness
