Balance of Payments Flashcards
Balance of payments
A record of all transactions between a country’s residents and the rest of the world over time
What is a stock?
- Sold in units called shares.
- A stock is a collection of shares
What is a share?
A unit of ownership, or equity, in a company or a corporation
What is transfer?
Transaction that does not involve an exchange
Debt forgiveness
The voluntary cancellation of all or part of a debt obligation
Bonds
Type of loan used by big corporations or governments to raise capital by selling IOU to general public
Direct investment
Investment where a resident controls or influences a foreign enterprise.
(Company to Company movement - Investment)
Portfolio investment
A grouping of assets such as stocks, bonds, and cash equivalents
Investment grants
Capital transfers made by governments or international organisations to fund specific investment projects
e.g. large construction projects
Payments in Current account
Exports/Imports:
- Goods/Services
- Visibles/Invisibles
Income: These are different forms of income
- Wages (for labor)
- Dividends (for shares)
- Interest (for capital)
- Remittances (sent home from workers abroad)
Current Transfers:
- (Foreign) Aid
Payments in Capital Account
(Capital flows)
- Funds
- Debt (& debt forgiveness)
- Government grants
- Capital
- Non-Financial Assets (e.g. Land, Real Estate, Companies)
Payments in Financial Account
Financial Assets:
- Shares
- Stocks
- Bonds
Loans
Reserve Assets (e.g. currencies, gold)
Direct Investment
Portfolio Investment
Definition of Current Account
A measure of the flow of funds from trade in goods and services, income and current transfers
What is Capital Account
- a measure of buying and selling of assets between countries
E.g. of assets:
- Land, Real Estate, Companies
- Capital transfers
- Transactions in non-produced, non-financial assets
E.g. of Non-produced, non-financial assets:
- Natural resources
- Contracts, leases and licenses
- Marketing assets (patents, trademarks, copyrights)
- Drilling rights
Definition of Financial Account
The net change in foreign ownership of domestic financial assets
- Direct Investment
- Portfolio Investment
- Reserve assets
Financial Assets
Non-physical, liquid assets with value from contracts, tradable on financial markets.
Examples of Financial Assets:
- Bank deposits at foreign banks
- Loan to foreigners
- Stocks and shares
- Government bonds
Current Account Balance
Current account = capital account + financial account
Current - (capital + financial) = 0
Why does it balance?
International trade involves goods, services, and resources exchanged for money or financial assets.
What is current account deficit?
- imports, income and transfers going overseas > exports, income and transfers coming in the domestic economy
- Net exports of goods and services + net income from investments + net transfers = Negative
What is capital account surplus?
capital inflows > capital outflows
Balance of trade
Trade balance:
- Export of goods - the imports of goods = Visible exports - visible imports
- Visibles - goods (can be touched)
- Invisibles - services (intangible, cannot be touched)
Trade deficit vs Current Account deficit
- Trade deficit only takes into account trade in goods
- Current account deficit includes trade in goods, services, income and transfer flows.
Export
Exports are goods that are sold in a foreign market. Money ends up in your country
Imports
Imports are foreign goods that are purchased in a domestic market. Money ends up in their country
Debit
transaction that leads to an outflow of foreign exchange - money flows out
Credit
transaction that leads to an inflow of foreign exchange - money flows in
Causes of Current Account Deficit (Imports > Exports)
- If the economy is at full employment (all resources are used in an economy)
- If you are less efficient than the rest of the world
Causes of Current Account Surplus
(Exports > Imports)
- Price of a country’s exports increases (and quantity is unchanged).
- Recession –> consumer cut down consumption, including imports –> export > imports
- If a country is more efficient than the rest of the world
Causes of Capital Account Surplus (Capital Inflow > Capital Outflow)
- High interest rate regime
- A devalued currency may attract a lot of foreign investment
Causes of a Capital Account Deficit
(Capital Inflow < Capital Outflow)
- Running a large debt service (Argentina) - i.e. having to pay back loans
- To run a current account surplus
Consequences of a Current Account Deficit
(Imports > Exports)
- Increase imports demand –> reduce domestic output –> causing layoffs and unemployment. (-)
- Increase imports demand –> AD decrease –> Recession (-)
- Increase in imports of capital goods may lead to a current account surplus in the future (+)
Consequences of a Current Account Surplus
(Exports > Imports)
- Can build up foreign reserves (+)
- Improves AD and leads to economic growth (-)
- Deindustrialization (-)
- Feedback effects (-)
- Can be inflationary (AD increase) (-)
- Depression of domestic living standards (-)
Implications of a persistent current account deficit (HL Only)
- Foreign ownership of domestic assets
- Exchange rates
- Interest rates
- Indebtedness
- International credit ratings
- Demand management
- Economic growth
Implications of a persistent current account surplus (HL Only)
- Lower domestic consumption and investment
- Appreciation of domestic currency
- Reduced export competitiveness
- Inflation
- Employment
Consequences of a Capital Account Surplus
(Inflow > Outflow)
- Provides investment in industries that may lead to further growth (+)
- Foreign investment boosts jobs, incomes, skills, and technology transfer, helping local industries grow. (+)
- May bid up real estate prices (-)
- May lead to foreign ownership of strategic assets (-)
Consequences of a Capital Account Deficit
(Outflow > Inflow)
- Opportunity cost involved in investing in another economy instead of your own (-) (increase employment and in foreign country)
- Income flows in the future (US invest in China –> US owned Chinese factory product –> profit back to US)
BOP and Exchange Rates (HL): Current Account
Current account surplus = appreaciation
- Demand for export increase = appreaciation
Current account deficit = depreaciation
- Demand for import increase = depreaciation
BOP and Exchange Rates (HL): Financial Account
Financial account surplus = appreaciation
Financial account deficit = depreciation
Ways a government can correct a persistent Current Account Deficit 1 : (HL)
Expenditure-switching policies:
Policies shifting spending from imports to domestic products
Ways a government can correct a persistent Current Account Deficit 2: (HL)
Expenditure-reducing policies:
Contractionary monetary/fiscal policies to lower the demand for imports.
Ways a government can correct a persistent Current Account Deficit 3: (HL only)
- Supply side policies
- Increase competitiveness
Marshall-Lerner Condition (HL Only)
Depreciation improves the current account if sum of export and import elasticities is greater than 1.
PED of X + PED of M > 1
J curve effect (HL Only)
Shows the impact of currency depreciation on the balance of trade (BOT) over time
Short run J curve
- Depreciation lowers export prices
- Inelastic (time lag) demand may reduce export revenue
- Import prices rise –> consumer still purchase bc lack of substitutes
- Current acc worsen
Long run J curve
- Demand for M and X are elastic
- Foreigners buy export –> revenue rise
- Consumer find subs for imports –> revenue fall
- Current account improve
Inverse J curve
Shows the effect of currency appreciation in a trade surplus –> worsened BOT initially –> improvement as consumers adjust.
