9. Balance of Payments Flashcards
Done up till expenditure reducing policy. Need to finish off.
What is the balance of Payments
it summarises all transactions between
residents of a nation and non-residents during a period. It includes the value of trade flows, investment incomes and other financial transactions across national borders.
Three elements of BoP
The current account
The capital account
The financial account
What is the current account
The current account records payments for trade in
goods and services plus net flows of primary and
secondary income.
What 4 things make up the current account
Net balance of trade in goods
Net balance of trade in services
Net primary income
Net secondary income
What is primary income
Primary income measures the monetary flows
generated from the owning of cross-border financial
assets, known as investment income. It represents
the yields (returns) from UK investments abroad and
that of foreign-owned investment in the UK. Primary
income also includes pay for cross-border workers
such as migrants.
Which income flows appear in primary
Income on Direct Investment:
Income on Portfolio Investment:
Compensation of Employees:
Taxes on Income and Wealth:
What is secondary income
Secondary income in the context of the balance of
payments is “current transfers between residents
and non-residents” – Examples of secondary income
transfers include foreign aid, and contributions to
international organisations such as the United
Nations and the European Union – which the UK has
now left.
What money flows appear in secondary income
Remittances:
Foreign Aid:
Diaspora Contributions:
Payments made to international institutions:
Remittances and the current account
Remittances are typically
categorized as a credit item in
the current account,
contributing positively to the
current account balance.
In many lower-income
countries, remittances can
offset trade deficits or other
current account deficits,
helping to achieve or
maintain a current account
surplus.
What is the financial account of the BoP
The financial account includes transactions that result in
a change of ownership of financial assets and liabilities
between a country’s residents and non-residents.
What does the financial account of the BoP include
This includes:
Net balance of foreign direct investment (FDI)
Net balance of portfolio investment flows
(inflows/outflows of debt and equity)
Balance of banking flows (such as hot money flowing
in/out of a country’s commercial banks)
Changes to the value of a country’s reserves of gold
and foreign currency
What is the capital account and what does it include
Capital Transfers: Capital transfers involve the transfer of assets without any
exchange of economic value, such as debt forgiveness, gifts, and inheritance.
These transfers can be between governments, institutions, or individuals.
Non-produced, Non-financial Assets: This category includes the sale and
purchase of non-financial assets like patents, copyrights, and licenses, as well as
the transfer of natural resources and land ownership between countries.
What are net errors and omissions
Net errors and omissions reflect the
imbalances resulting from imperfections in
source data and compilation of the balance of
payments accounts. They are needed to
ensure that accounts in a country’s balance of
payments statement always sum to zero.
What is a current account defecit
A current account deficit means that the value of a country’s exports of goods
and services, investment incomes and transfer inflows are lower than spending
on imported goods and services, investment income outflow and outward
transfers.
Effectively, it means that there is a net outflow of income from a country’s
circular flow.
What does a current account deficit show
A current account deficit can be a sign of economic weakness, as it means that
the country is relying on borrowing from abroad to finance its consumption.
However, it’s not always a bad thing, as a current account deficit can also be the
result of strong economic growth or investment in importing new capital goods.
How is a current account deficit financed
The UK is the net borrower from the rest of the world
UK needs to attract financial inflow
by:
1.Uk stock market rising
2.High interest rates attract inflow in banks
3.UK businesses sell overseas assets
4.Overseas investors purchase UK bonds
What causes a current account deficit
Cyclical causes: When an economy is
experiencing a boom, rising real
incomes and consumer spending
and falling savings ratios can lead
to a surge in import demand
which can cause an increase in
the size of a trade deficit.
Structural causes: Structural causes focus on supply-side weaknesses in an economy such as relatively low capital investment, low
productivity & research and
businesses not operating at the
cutting edge of innovation.
Short run causes of current account deficit
A fall in the value of exports perhaps caused by a decline in the world
price a nation’s major export
A boom in consumer spending (and fall in saving) which leads to
increased consumer demand for imported goods and services
A strengthening (appreciating) exchange rate which might make a
country’s export sector less price competitive in overseas markets
A broadly-based economic boom leading to rising import demand
Long run causes of current account deficit
Low rates of capital investment which limits the overall productive
capacity and cost competitiveness of key export industries
Relatively high cost & price inflation contrasted with trade partners
Weaknesses in non-price competition such as branding & innovation
Long-term decline of previously dominant export sectors such as
deindustrialization in manufacturing, decline in extractive sectors
Explain how an economic boom can causes a external deficit
Strong rise in consumer spending -> Large number of imports -> Limited spare capacity domestically so the exports dont change -> external deficit
Explain how a strong currency can cause an external deficit
Exports become less price competitive -> less demand for UK exports -> imports cheaper -> consumers switch to overseas products
Explain how low productivity can cause an external deficit
Lower productivity compared to competitors -> High unit wage costs -> Exporting firms are in a price and cost disadvantage -> slow down in exports ->
Causes of current account deficit
Poor price and non-price competitiveness
Strong exchange rate
Volatile global prices of key exports and imports
High propensity to consume imports on behalf of consumers
Macro effects of a current account deficit
Fall in AD since (X-M) is negative – leading to slower GDP growth
Drag on GDP growth might then lead to weaker investment & jobs
Large external deficit likely to lead to a depreciating exchange rate
High external deficit may reflect weaknesses on the supply-side
Deficit must be financed by attracting a net flow on the financial
account by allowing overseas buyers to acquire a nation’s assets
Policies to improve Trade deficit
Macroeconomic policies include adjusting interest rates, changing the
exchange rate, or altering fiscal policy.
Targeted interventions can include subsidies to exporters, tariffs on imports,
and even direct government intervention in industries.
Expenditure switching policies
These are policies designed to change the
relative prices of exports and imports. For
example - an exchange rate depreciation can
improve the price competitiveness of exports
and make imports more expensive when
priced in a domestic currency.
What are examples of expenditure switching polices
Central bank intervention to lower the external value of a currency
Government subsidies to domestic producers
Import tariffs designed to increase the price of imported products
Period of internal devaluation (a falling domestic price level) to
improve price and cost competitiveness of domestic businesses
How does depreciation of the exchange rate work as a expenditure switching policies
Reduces relative price of exports & makes imports more expensive
Evaluation : Risk of cost-push inflation – which erodes competitive boost + fall in real incomes / standard of living
How does import tariffs work as a expenditure switching policies
Increases the price of imports & makes domestic output more price competitive
Evaluation: Risk of retaliation from other
countries if import tariffs are used
as BoP policy
How does low rate of inflation work as a expenditure switching policies
Keeps general price level under
control and makes exports more
competitive
Evaluation:Risks from deflation as a way of
achieving internal devaluation –
including lower investment
What are expenditure reducing policies
These are contractionary monetary and fiscal policies designed to lower real incomes and aggregate demand and thereby cut the demand for imports.
Policies might include higher direct taxes, cuts in real government spending or an increase in monetary policy interest rates to lower demand for credit and increase saving.
Examples of expenditure reducing policies
Rise in burden of direct taxes such as higher income taxes
Cuts in government spending on welfare
Cuts in government spending on public services
How does increasing income tax work as a expenditure reducing policy
Reduces real disposable incomes
causing falling demand for
imports
Evaluation: Cut in living standards and risk of
causing damage to work incentives
in labour market
How does Cuts in real level of
government spending work as a expenditure reducing policy
Lowers aggregate demand, firms may look to export to make fuller use of their spare capacity
Evaluation:Damage to short term economic growth, risks that austerity hits planned business investment which could worsen the trade balance in the longer-term.
FLASHCARDS MADE UP TILL THE EXPENDITURE REDUCING POLICY
