6.3 Current account of the balance of payments Flashcards
What are the balance of payments?
It is a record of all financial transactions made between consumers, firms and the government from one country with other countries.
The account must BALANCE. financial account and current account go hand in hand.
If a country like China has a CA surplus they are sitting on bread. You can buy financial account stuff with his bread and you will buy from countries who have a CA deficit. This will increase the FA of the other country which balances out the BOP
What are exports?
They are goods and services sold to foreign countries and are positive in the BOP. This is as they are an inflow of money
What are imports?
They are goods and services bought from foreign countries and are negative on the BOP. They are an outflow of money
What are the balance of payments made of?
The current account
The capital and financial account
The balancing item
What is the current account?
This includes all economic transactions between countries.
The main transactions are the trade in goods and services, income and international transfers
What is the meaning of BOP equilibrium and disequilibrium?
Equilibrium is when the components of the BOP should balance = 0
Disequilibrium is when there are large current account deficit or surpluses
What are the causes of current account surplus and deficits?
surplus is when exports>imports
deficit is when imports>exports
Appreciation of the pound - stronger currency means imports are cheaper and exports are relatively more expensive, which means the deficit would worsen
Economic growth - as income increases, demand for imports may increase
More competitive - if a country becomes more internationally competitive, exports should increase. This could cause the current account deficit to improve
FDI - this inflow of investment into the country could lead to a surplus
what is the calculation of a balance of trade in goods/services?
Total value of exports - total value of imports
What are the consequences of imbalances in the current account on domestic and external economy?
If imported raw materials are expensive, there could be cost-push inflation in the domestic economy since firms face higher costs
International trade has meant countries have become interdependent. Thus, the economic conditions in one country affect other countries as the quantity of the imports and the exports will change
It could be difficult to attract financial flows in order to finance a current account deficit. This could make it unsustainable in the long run
CA deficit consequences:
Could lower AD in economy. This is as trade balance is the biggest component and if there is a deficit they have a negative trade balance which applies net exports is negative which is pulling down AD. This leads lower growth in the economy and higher unemployment
Huge debt burden - people might lose confidence in a countries ability to pay the debt back. If investors pull away from buying debt in this country then all of a sudden people get worried. Fear of economy defaulting more people move away from the country which means sell the pound, massive currency crisis. WIDEC. People who have savings will move as well which depreciates pound even more which can lead to an overall financial crisis in a country
CA deficit can put downward pressure on the exchange rate. If a country is importing more than it is exporting then it is actually selling to the rest of the world. Overall the supply of the currency is increasing and shift it to the right. Net imports to UK will be more than exports which will put downward pressure on the pound and it could partially correct a CA deficit due to widec
Expenditure reducing and switching policies to reduce CA deficit
Expenditure reducing policies work by reducing AD and incomes in an economy and therefore reduce the marginal propensity to import. Contractionary monetary and fiscal policies will help do this.
However big conflict of objectives, growth falls and unemployment increases which could lead to a recession in the economy. Inflation might also go blow the target rate. Could consumer and business confidence be so high that AD doesn’t fall if IR rise. Size of the output gap. No guarantee of decrease in incomes etc. Question the marginal propensity to import. If it’s not every high then these policies wont make enough of an impact to close CA deficit
Expenditure switching policy is to use protectionism such as tariffs quotas embargoes. This is so govs can target certain imports of goods and services and use protectionism to reduce import expenditure. Or SWITCH spending to domestic goods instead.
But there will be retaliation which can make the CA deficit worse. Your trading partners overseas will put even worse tariffs on EXPORTS of our very own goods and services. Export revs may fall more than the import expenditure we are saving. WTO might not like it and can be heavy fines. Protectionism can be inflationary. Higher prices for consumers. Loss of efficiency.
Expenditure switching policy - weaken the exchange rate. A weaker exchange rate WIDEC. Imports more expensive then demand will decrease and opposite if they are cheaper. Central bank to reduce IR which means a hot money outflow which means more selling of the currency which leads to WIDEC. An increase in the money supply through QE increases supply of the money and reduces value of exchange rate. Maybe central bank can sell domestic currency reserves. This way they are creating extra supply of their own currency which reduces the value of it. Can be inflationary from the cost push side or the demand pull side. Also purposeful weakening exchange rate can have strong retaliation to that which leads to big currency wars
Supply side policies to boost international competitiveness either in terms of price or competitiveness
Evaluation:
Conflict of objectives
Cause of a CA deficit
Time lags / cost
Is the CA deficit really a problem?
Causes and consequences of a CA surplus:
Very likely they have a trade surplus.
Demand side causes are high incomes abroad which means demand for our exports increase. Maybe low incomes at home which reduces the demand for imports. Maybe WIDEC.
Supply side causes. Low relative inflation which makes your goods more competitive. Low unit labour costs due to high productivity weak trade unions and low min wages which increases competitiveness of exports. Maybe strong investment which can keep prices low and make them more price competitive. Gains in comparative advantage. New resource discoveries
Consequences:
Higher trade surplus means X-M positive which increases AD which means growth increases and unemployment decreases but potentially demand pull inflation could increase. More demand for exports than imports which means there will be more demand for the currency than there will be supply of it. As a result there could be SPICED. Must be running a financial account deficit in order to service their fat CA surplus. Can harm international relations. Could be using excessive protectionism like managing their exchange rates and dodgy stuff etc. Countries with CA deficit might retaliate
