Balance Of Payments Flashcards
What does the current account measure?
- Trade in goods- value of goods exported- value of goods imported
- Trade in services- value of services exported- value of services imported.
1 AND 2= BALANCE OF TRADE.
- Income- earning of foreign investments. Payments made to foreigners.
- Transfers- payment of eu fees. Paying aid to other countries.
NOT MEASURING VOLUME. MEASURING VALUE
What is the definition of a current account?
Records payments for transactions between countries in the present year.
What is a current account surplus?
Implies that a country’s current account is positive.
What is a current account deficit?
Implies that a country’s current account is negative
What are the causes of a current account deficit?
Strong domestic growth- means incomes are high and they want more stuff and a lot of this stuff needs to be imported which increases imports which means the amount of money leaving the country increases, worsening current account balance
Recession overseas- incomes abroad are falling, demand for exports will fall, revenue generated for exports will decrease
Strong exchange rate- SPICED- imports cheaper and exports expensive. If exports are expensive we aren’t gonna export as much, revenue generated from exports decreases.
Low investment-
High levels of consumption- If a country’s citizens have a very high MPI, and the country’s growth is heavily consumption-led, this means that as the country grows it is likely to increase import expenditure at a fast rate. This would worsen (make more negative) the trade balance on the current account, which could cause a current account deficit
Low productivity-
High rate of inflation-
What are the consequences of a current account deficit?
Causes aggregate demand to fall as (X-M) is negative. Causes a reduction in growth. Also might imply, country’s goods are uncompetitive which causes an increase in unemployment. However, it depends on size of deficit, if its a small percentage of gdp so the effect on aggregate demand isnt much.
If current account deficit is caused by demand side policies then this is a good consequence and it depends where it has been caused as if its a supply side policy then this may be harmful in the long term.
What are the causes of current account surpluses?
RIPES
Recessions- This could lead to domestic producers struggling to sell products domestically, and so they may compete harder in international markets leading to higher export revenue. Import expenditure is also likely to fall due to the falling incomes which will decrease consumption and thus the quantity demanded of imports. This would improve (make more positive) the trade balance on the current account, which could cause a current account surplus
I ( HIGH INVESTMENT INCOME)- The profits coming home from overseas branches of firms (branches of an MNC owned by a domestic citizen), the interest from money held in banks overseas and/or dividends from equity stakes / shares in foreign firms (not created by domestic citizens) can cause current account surpluses, if they are in high levels, as primary income will be higher as a result
PROTECTIONISM- Protectionism in the form of tariffs (taxes on imports), for example, would likely lead to lower import expenditure as imports would be less price competitive against domestically produced products (as the tax would make them artificially more expensive), reducing quantity demanded for them. This would improve (make more positive) the trade balance on the current account, which could cause a current account surplus
LOW EXCHANGE RATE- A low exchange rate would make exports cheaper and imports more expensive. This would likely lead to an increase in export revenue due to the fact that their increased price competitiveness would likely increase the quantity demanded of exports. Conversely, it would likely lead to a decrease in import expenditure due to the fact that their reduced price competitiveness would likely reduce the quantity demanded of imports. Improves trade balance on current account which causes current account surplus.
What are the problems with current account surpluses?
Current account surpluses can be a sign of competitiveness and growth however can also be a sign of problems:
Unsustainable economic growth- If a country’s growth is heavily export-led, and the country is not partaking in sufficient capital investment, this can lead to very high levels of inflation which, of course, will bring with it all of its costs. Additionally, if the country exports mostly finite resources, this may harm future generations and their ability to take advantage of high levels of real output in the future. The dependency on the finite resources could potentially lead to a deep economic recession once the resources have mostly depleted and been exported
What is the relationship between current account imbalances and other macroeconomic objectives?
If a country has persistent current account deficit it might imply the country’s goods are uncompetitive which could cause an increasing level of unemployment.
Leads to a fall in the rate of economic growth. Could cause a fall in country’s exchange rate against other currencies. Causes an increase in import prices, which could be inflationary.
