Balance Of Payments Flashcards
What is the balance of payments
A record of all transactions between one country and the rest of the world
What are the subcomponents of balance of payments
Financial account
Current account
Capital account
How does the balance of payments always sum to zero
If you have a current account deficit, you must have an equal and opposite capital/financial account surplus
What is the current account made up of
Trade in goods, services
Primary and secondary jncome
What is the financial account made up of
Short run capital flow eg hot money
Long run capital flow eg FDI
What is primary income
Income generate by UK citizens through ownership of foreign assets minus foreigners income generated from ownership of UK assets eg dividends
What is secondary income
Transfer payments (payment made not in exchange for a good/service). Ie foreign aid
Why does the balance of payments balance
We need an inflow of capital to be able to pay for imports.
Ex: when someone exports a good, they receive a financial asset (cash) in return. A credit entry into the current account represents this export, and the financial asset acquired represents a debit entry in the financial account. This works because economic transactions are 2 sided: something of economic value is provided, and something of equal value is recieved
Why do current account deficits occur
Uncompetitive exports - (poor productivity)
High consumer spending
Overvalued exchange rate
Decline in export sector
Higher inflation (what is it relative to other countries?)
More expensive factor costs (high NMW)
Sources of comparative advantage?
Protectionist policies
What is a structural current account deficit
A deficit which is the norm in a country, probably due to supply side issues like weak export sectors
What is the terms of trade index
Index of export prices / index of import prices
X 100
What happened to exports with price changes in elastic and inelastic goods
Elastic:
Price increase —> TOT up, but current account worsens
Price down —> TOT down, but CA better
Inelastic:
Price increase —> TOT up, CA better
Price decrease —> TOT down, CA worse
What happens to imports with a change in price for inelastic and elastic goods
Elastic:
Price up —> TOT down, CA better
Price down —> TOT up, CA worse
Inelastic:
Price up —> TOT down, CA worse
Price down —> TOT up, CA better
How can countries deal with sustained supply side deficit in current account
Protectionism - reduced imports
Encourage Export industries
Supply side reforms to increase productivity and competitiveness
Exchange rate policies ie depreciation of the currency to make exports cheaper, imports more expensive
Deflationary policies to make our goods more price competitive
Evaluation of means of reducing trade imbalances
Supply side policy eg investment in education might worsen the deficit country’s budget balance (more SR) also there are time lags
Protectionist policies risk retaliation, so consumers worse off and exports fall
How far can exchange rates be managed by governments, with how important FOREX traders are. Also impact of exchange rate depends on Marshal-Lerner condition
Deflation has lots of negative effects
