Balance Of payments Flashcards
Balance of payments
The record of all money flows or transactions between the residents of a country and the rest of the worlds economy’s in a period of time
Current account
Measures the currency flows into and out of the country including trade income, FoP, primary and secondary income.
Why might the current account be the most important part of the BOP
Reflects the economy’s international competitiveness and the extent the country is living within its means
Primary income flows
Net income flows made up of investment generated from profit dividends and shares
Flowing between countries
Example of primary net income
Japan Nissan investment into Sunderland UK
Secondary income flows
Current transfers e.g aid charity overseas
E.g. UK contribution to the EU budget pre brexit
Financial account
Part of the BOP which records capital flows in and out of the economy including net fdi, net portfolio investment and short term speculative capital
Foreign direct investment
Investment in capital assets such as manufacturing
E.g. Japan nissanninto UK 1980s and 90s
Short term capital flows
“Hot money”
Largely speculative
Quick speculative profits can be made by moving between appreciating currencies
Also by high interest rates
Expenditure reducing policy
A government policy which aims to eliminate the current account decide by reducing the demand for imports and reducing AD
Expenditure switching policy
A government policy which aims to eliminate the current account deficit by switching domestic demand away from imports to domestically produced imports
Three main policies to reduce deficit caused by an overvalued exchange rate
Expenditure reducing - Deflation - contraction are monetary or fiscal policy
Expenditure switching-
Direct controls - imports quotas tariffs
Devaluation - lowering the exchange rate
What does deflation (expenditure reducing) involve
Using contractionary monetary or fiscal policy
Reducing the domestic price inflation relative to IR deflation improved the price competitiveness of exports and reduces that of imports
Criticism of deflation (expenditure reducing policy)
Small impact
Output, income and employment falls rather than the price level
Government sacrifice the domestic economic objectives of full employment and economic growth
Benefits of expenditure reducing deflation
When the economy is overheating it can control domestic inflationary pressures as well as correct a BoP deficit
What does direct controls include
Quotas or embargoes
Directly cutting expenditure
However does not cure the underlying cause (uncompotitiveness of a country’s goods)
Protectionism reduces specialisation and world trade/oupit/welfare to fall
Why is the UK unlikely to use direct controls
Member of the WTO and the EU
Devaluation effect of elastic demand for exports and imports
Likely to result in a reduction in the current account deficit
exports appear cheaper to foreigners
imports become more expensive as a lower exchange rate means more currency is needed to buy the same amount of foreign currency leadinig to a lower quanitity of imports
Factors determining a current account balance
1.labour productivity/output (price and quality competitiveness and success of SSPs)
2.inflation relative to competing nations
3.exchange rate - rising er increases foreign currency prices and reduces competitiveness
Short run deficit benefit
Living standards may increase
Long run deficit negatives
Decline of industries competitiveness and lower living standards
negatives of devaluation (expenditure switching)
makes imports more expensive for domestic consumers
depends on PED for X and M, which needs to be elastic to ensure demand for X rises and M falls
if PED elastic for both then will not lead to significant enough changes
marshall learner conditition
states that devaluation will improve CA only if PED for X and M together is greater than 1
J curve
demand becomes more elastic overtime
more substitutes become available
X prices fall but this wont lead to higher X prices immediately
only if higher elasticity of demand
M more expensive than X after devaluation, but D will not fall much in short term as inelastic (more is spent on M until X becomes more elastic)
