6.3 The Balance Of Payments Flashcards
Balance of payment definition
A record of all the financial transactions taking place between one country and any other country
What three sections are the balance of payments broken down into
- capital account
- financial account
- current account
What is the capital count?
Capital account includes capital transfers as well as purchases and sales of some non-financial assets
What is the financial account?
Measures the flows of financial capital into and out of the country. It consists of FDI, portfolio investment and short-term speculative money (hot money)
Foreign direct investment definition
The buying of productive assets (businesses, CELL) located outside the country of ownership
Portfolio investment definition
Refers to the buying of financial assets located outside the country of ownership. (Stocks and shares)
Current account definition
Measurement of the net income from trade in goods and services and primary and secondary income
What are the four components of the current account?
- trade in goods
- trade in services
- primary income
- secondary income
Primary income definition
The net income earned from investments abroad or outside the country of origin
Why has recently the UK net investment income become a deficit in recent years?
Rapid growth in countries such as China and India has led to invests INTO the Uk, thus creating floes of investment income back to those countries
Secondary income definition
Related to the transfers of money between countries
What are four examples of secondary incomes
- remittances
- foreign aid
- grants
- gifts
Is the current account for the Uk in surplus or deficit, and why?
Deficit, because the trade on goods is in deficit and outweighs the surplus on the trade of services
What are the factors that determine the current account
- foreign GDP
- productivity
- inflation
How does foreign GDP affect the current account?
As foreign GDP rises, spending in those countries will also rise and this will lead to greater demand for imports = UK goods and services = UK current account surplus
How does productivity affect the current account?
If UK productivity rises relative to foreign productivity, this means UK firms can produce more output for less inputs = decrease cost of production = firms can be more price competitive compared with foreign substitutes = increase in UK exports = surplus on current account
How does inflation affect the current account?
If UK inflation is relatively higher than foreign inflation it means the prices of UK goods are rising faster than those produced overseas = less price competitive = lower exports = current account deficit
- not the rate of inflation but the level of relative inflation
What are expenditure reducing policy’s?
Deflationary policies
What are expenditure switching polices?
Protectionist policies and devaluation
Expenditure reducing policies definition
Policies to improve the current account balance by reducing spending in the economy
Expenditure switching policies definition
Policies to encourage a switch away from imports and to encourage a growth in exports
What are the types of expenditure reducing policies?
- higher taxation
- lower government expenditure
- higher interest rates
What do expenditure reducing policies aim to do?
Reducing Uk consumer spending on imports by reducing the ability of Uk consumers to spend money
What is the aim of expenditure switching policies?
To reduce the quantity of imports accompanied by a rise in the quantity of exports
Explain how devaluation is an expenditure switching policies
- Devaluation leads to exports being cheaper to foreign customers = increase in exports
- imports become more expensive = more domestic goods used instead as cheaper = less imports
What are the issues with devaluation?
It may improve the current account balance but will depend on the elasticity of demand for both exports and imports
Devaluation definition
A sudden and significant fall in the value of the exchange rate
Marshall-Lerner condition definition
The requirement that devaluation will improve the current account balance only if the total of the price elasticity was for imports and exports is greater than 1
What is the J curve?
The observation that after a devaluation. The current account balance worsens initially before improving
Describe how the J curve works
Demand usually becomes more price elasticity over time as more substitutes are found
- exports prices falls but does not immediately lead to higher exports. An increase occurs over time as demand becomes more price elastic
- imports become more expensive but demand dosent fall much as demand is price inelastic but over time, it changes as substitutes are found
= current account worsens in the short-term but gets better in the long-term after the devaluation
What are the types of expenditure switching policies?
- devaluation
- protectionist polices
- supply-side polices
How do supply-side policies help the balance on the current account?
- improves the productivity of the economy = reduces cost of production per unit = lower prices = more price competitive = more exports
Why are current account deficits to be avoided?
- they mean a net outflow of money leaving the UK economy = withdrawals
- may signify a weakness in the country’s export industries e.g poor technology
- if the exchange rate is fixed, a deficit may persist
- more expensive costs for Uk businesses = inflation
Why may a current account deficit not matter?
- could signify higher incomes = economic growth
- depends on the size of the deficit based on the countries GDP
