Balance Of Payments Flashcards
Define BOP (balance of payments)
It is all the financial transactions made between consumers, businesses and the government in one country with other nations
What are the 3 accounts
Current
Capital
Financial
What does the current account include
Takes up majority of the balance
The balance of trade in goods and services
Net primary income (interest, profits, dividends)
Net Secondary income (Contribution to EU, military aid)
What does the capital account include
Transfers of the ownership of fixed assets.
Debt forgiveness
Sales/transfer of patents, copyrights, franchises, leases
What does the financial account include
Takes up more of the balance than the capital account
Portfolio investment
Assets such as shares, bonds
FDI
How is a cyclical BOP deficit or surplus caused
A cyclical BOP deficit or surplus is caused by the state of the economy such as if in a boom, tax receipts are high and spending on unemployment is low.
How is a structural BOP surplus or deficit caused by
A structural BOP deficit or surplus is cause by structural factors such as supply side causes(education)
What are the causes of a structural current account surplus
Long run technological advancement
Long run rise in global prices of main exports
Structural increase in net investment income
Trend rise in factor productivity
What are the causes of a cyclical current account surplus
Depreciation of the exchange rate
Strong consumer demand in export markets
Cyclical improvements in terms of trade
Fall in costs of essential imports
Define terms of trade
The terms of trade measures the volume of imports an economy can receive per unit of exports
What is the formula for terms of trade
Formula:
Average export prices (index) / Average import prices (index) x 100
How does the terms of trade improve
If export prices increase compared to import prices, the term of trade improves.
What are the benefits of a current account surplus
Contributor to GDP
Increased employment
Economic stability
What are the causes of a structural current account deficit
Under investment
Low productivity
Constant high inflation
Low innovation
What are the causes of a cyclical current account deficit
Overvalued exchange rate
Recession in key export markets
Fall in global prices of exports
Increased demand for imported technology
How is depreciation a policy to reduce a BOP deficit
Depreciation involves reducing the value of the currency against others and making exports cheaper (^competitive) and imports more expensive.
However, it will depend on the elasticity of demand for exports and imports, demand needs to be elastic for devaluation to be useful.
How is reducing consumer spending a policy to reduce a BOP deficit
Reduce consumer spending, the government could pursue tight fiscal policy (higher taxes to reduce consumer spending) or increase interest rates to reduce spending, this will cause less spent on imports therefore improving the current account.
However, this policy will conflict with other macroeconomic objectives.
How does supply side policies reduce a BOP deficit
Supply side policies, these are policies aimed at increasing productivity and competitiveness, if successful this will make UK exports more competitive and export demands will rise.
This will take a while to come into effect but this will help other areas of the economy such as economic growth.
How does protectionist measures reduce a BOP deficit
Protectionism, putting tariffs on imports could lead to a fall in import spending and improve the current account
But this will likely lead to retaliation and a fall in exports.
What are drawbacks to a large current account surplus
It represents an unbalanced economy — dominated by exports and showing low levels of consumer spending.
If one country runs a large current account surplus, it means other countries will have a similar deficit.
In the Eurozone, current account imbalances are more of a problem because countries can’t rely on a depreciation to solve the imbalance.
How could the government reduce a current account surplus
Allowing the exchange rate to appreciate, reducing competitiveness.
- Encouraging consumer spending (e.g. lower income tax), leading to higher import spending.
What is the effect of having a current account deficit
Lower AD.
A deficit (X-M) represents a leakage from the economy. Money is being spent in other countries and, therefore, ceteris paribus, it reduces UK aggregate demand. On the other hand, a current account deficit may occur due to high levels of consumer spending and economic growth.
Depreciation.
A current account deficit could cause a depreciation in the value of the exchange rate, because we are buying imports and, therefore, buying foreign currency. A depreciation will improve the current account, because it makes exports more competitive.
What are the general causes of a current account deficit
Appreciation
High economic growth (more spending on imports)
Membership of Trade union (EU)
What are the general causes of a current account surplus
More competitive (depreciation)
High interest rates
