Balance of Payments Flashcards
components of BOP
current
capital
financial accounts
net errors and omissions, which is the figure included to ensure the BOP balances
components of current account
-trade balance (X-M)
-primary income - factor income and
-employee’s compensation
-secondary income - transfer payments b/w international orgs; aid; remittances
components of financial account
- FDI - inward and outward
- portfolio investments in bonds and shares that do not involve legal control of firm
- reserves of gold and FOREX (to settle debt and control ER)
- bank deposits and loans
difference between credit and debit terms
credit = outflows
debit = inflows
evaluate the impact of a financial account deficit
- may only be SR due to hot money flows, and in the LR will increase profits, interests and dividends on the CA (FDI)
- depends on the cause - if due to LT lack of confidence in economic prospects, may result in capital flight, which reduces tax revenue, employment and growth
define capital flight
rapid movement of large sums of money out of a country as residents move money from domestic to foreign banks and firms move some production abroad, due to a lack of confidence in a country’s economy or currency or political turmoil.
evaluate the impact of a financial account surplus
in the SR, will finance a deficit on the CA and increase employment and growth, e.g. new FDI projects
in the LR, will result in deficit on primary income account (profits, dividends, interest, wages) of CA unless offset by an increase in country’s outward FDI and portfolio investment
define the capital account
the balance of non-produced, non-financial assets like govt debt forgiveness, changes in migrant assets, sales and purchases of intellectual property rights
why is the balancing item needed?
in theory, deficit on the CA should be balanced by equal surplus on capital and financial accounts as every credit item is matched by a debit item
in reality, it is hard to track such a huge number of transactions so errors occur that do not make the BOP balance.
e.g. if CA + CAP + FA = -2000m, a value of 2000m must have been missed out, so that would be the value of the balancing item
however, the value of the balancing items tends to fall over time as the quality of info improves
define expenditure-switching policy
policy tools designed to encourage people to switch from buying imports to buying domestically produced products to improve the CA
define expenditure reducing policy
tools designed to reduce imports and increase exports by reducing the overall level of AD and expenditure in the economy, which reduces imports and gives domestic producers an incentive to increase exports to make up for lost domestic dmand
what are some policies used to correct CA imbalance?
con. fiscal
con monetary
SSP
ER devaluation
protectionism
***SSP and protectionism only used to correct deficit, not surplus
what are some policies used to cause a financial account surplus?
SSP policies to increase competitiveness and productivity; increase macro stability; reduce red-tape and COP
both interventionist and MB SSP
why would the govt want a FA surplus?
to promote econ development through inward FDI and employment income growth
selling shares in domestic firms will provide funds for investment and expansion
to finance a CA deficit
how does a FA surplus finance a CA deficit?
where is international borrowing recorded on the BOP and is it a credit or debit?
examples of ES policies
ER policy - competitive devaluation/depreciation
protectionism - tarrifs, quotas, subsidies
SSP - any IN or MB policy to increase productive efficiency and international competitiveness
examples of ER policy
contractionary fiscal
contractionary monetary
BE SPECIFIC - e.g. is it taxes or spending? IR?
evaluate the use of ex red policy
- general arguments against FP and MP
- conflict of macro objectives of growth and unemployment and inequality/redistribution
- depends on the MPM abroad - may be low so will not be able to increase domestic X
evaluate the use of protectionism as ES policy
- retaliation may worsen deficit
- inflationary if imports have low PED like oil/food
- depends on PES of X - can producers sell more?
- regressive impact on consumers (CS)
- may break WTO rules on free trade - penalties
evaluate the use of ER policy as ES policy
- Marshall Lerner and J-Curve effect
- causes DP and CP inflation in LR that offsets competitiveness gain
- retaliation offsets
evaluate the use of SSP as ES
any generic arguement e.g. time, cost, no guarantee, needs to be targeted, unintended consequences like structural unemployment
evaluate whether ES or EXRED policy should be used
- regardless of choice need to consider the trade-off so maybe SSP or policy combo would be best
- depends on cause of CA deficit - cyclical or structural?
- SR/LR effects - for immediate effect, ER, but for LR need SSP
- is deficit large enough percentage of GDP to be a problem? Also may not be harmful because…
- weigh up costs of policy with govt finances for SSP
why might a CA deficit not harmful?
- if ER is floating like the pound, will self-correct
- depends on how it is being financed - sustainably with inward FDI or unsustainably with debt?
- depends on country - e.g. people may have more confidence in the US compared to a developing country, so can be sure of attracting a FA surplus through investments and less risk of capital flight
