Balance of payments

Question 1

What is the balance of payments?

Answer 1

A set of accounts recording all transactions conducted between residents of that country and residents of all other countries.
> anything that gives rise to the flow of money across international boundaries is recorded in the balance of payments.

Question 2

Transactions between residents of different countries involve activities such as…

Answer 2

• importing and exporting goods
• investments in financial assets
  > eg: stocks, bonds, buying properties
• investments in multinational corporations
• sending or receiving gifts

Question 3

How are transactions recorded?

Answer 3

• Inflows of money from residents abroad are recorded as credits (+)
• Outflows of money to residents abroad are recorded as debits (-)

Question 4

What do credits and debits represent in the UK?

Answer 4

• Credits
  > inflows of money from abroad can only be made if foreigners buy pound sterlings (£)
  > so, credits represent a foreign demand for £s
• Debits
  > outflows of money from the UK to foreigners can only be made if foreigners buy £s
  > so, debits represent a selling of £s to buy foreign currency

Question 5

What are the components of the balance of payments ?

Answer 5

1) Current account

2) Capital and financial accounts

Question 6

What is the current account?

Answer 6

• Current account is where payments for the purchase of goods and services are recorded.
  > inflows minus outflows in money terms

Question 7

What does the current account record?

Answer 7

1) Visible balance of trade
= Exports (of country’s goods) - Imports (of country’s goods)

2) Invisible balance of trade
= Exports (of country’s services) - Imports (of country’s services)

3) Net primary income
= Inflows (of wages, rents, interest, profits from abroad) - Outflows (of wages, rents, interest, profits)

4) Net secondary income
= Inflows (such as gifts, foreign aid) into the country - Outflows (such as gifts, foreign aid) sent out of the country

Question 8

What are the capital and financial accounts ?

Answer 8

Where flows of money associated with saving, investment, speculation, currency stabilisation are recorded.

Question 9

What is recorded in the capital account ?

Answer 9

1) Capital transfers
= Inflow (of debt forgiveness, investment grants) - Outflow (of debt forgiveness, investment grants)

2) Transfers of non-produced, non-financial assets
= Inflow (of natural resources that have not been produced, eg: land, mineral rights, forestry rights, water, fishing rights) - Outflow (of natural resources that have not been produced)

3) transfers recorded are those of immigrants and emigrants
> bringing financial capital into UK or taking it abroad

Question 10

What does the financial account record ?

Answer 10

1) Foreign direct investment
= investments in physical capital (usually undertaken by multinational firms)

2) Portfolio investment
= includes flows of money to purchase foreign shares were this is less than 10% of the company
> shows investment in financial assets (savings, shares and bonds)

3) Reserve assets
= Foreign currency reserves that the central bank can buy or sell to influence the value of the country’s currency in a fixed exchange rate system.

Question 11

Countries can expect surpluses and deficits to occur in the short run because the current account is made up of millions of different transactions.
In the long term countries can be split into 3 groups…

Answer 11

1) Countries where the current account broadly is in balance
> France and Chile

2) Countries which run persistent current account surpluses
> Norway, China, Germany, Switzerland

3) Countries which run persistent current account deficits
> UK, US, Turkey, Poland, Australia

Question 12

What are the causes of persistent current account surpluses / deficits ?

Answer 12

1) Natural resources

2) Underlying competitiveness

3) Inflation

4) Investment and long term economic growth

5) Exchange rates

6) Spending by consumers and governement

Question 13

How do natural resources lead to current account surpluses?

Answer 13

• Some countries are abundant in natural resources relative to the size of their population
• This tends to cause current account deficits because there is little pressure to use the money from their exported goods (eg: oil in Saudi Arabia) to fund imports.

Question 14

How does underlying competitiveness lead to current account deficit / surplus ?

Answer 14

> surplus:
- Overtime, underlying competitiveness which makes their goods more attractive to foreign buyers
- Firms in a country may have developed a reputation