Balance of payments Flashcards
Balance of payment
A record of all currency flows into and out of a country in a particular time period
Should equal to 0
Current account
Measures all of the currency flows into and out of a country in a particular time period and payments for exports imports together with primary and secondary income flow
-Trade in goods
-Trade in services
-Investment and income
-Transfers
Current account deficit/surplus
If value of exports exceeds value of imports net exports is positive
Negative current account equals current account deficit and vice versa
Financial account
Records capital flows into and out of the economy
-Portfolio investment
-Foreign direct investment
-Reserves
Capital account
-debt, forgiveness
-Inheritance taxes
Demand side causes for current account deficit
-strong domestic growth
-Recession overseas
-Strong exchange rate
Demand side causes for current account deficit
Strong domestic growth
Income a high living standards are high and people are more willing to buy imports
Imports increase more money leaving the country
Demand side causes for current account deficit
Recession overseas
Income abroad are following
Less demand for exports means less money coming into the country
Demand side causes for current account deficit
Strong exchange rate
Imports are cheaper and exports are more expensive
More imports and less exports
Supply side reasons of the current account deficit
-Low investment
-Low productivity
-High relative inflation
-High unit labour costs
-Poor quality of goods made
-Depletion of resource resources(less to export)
Consequences of a current account deficit
-Lower aggregate demand
-Debt burden
-lower exchange rates
Consequences of a current account deficit
lower aggregate demand
current account deficit means net exports is negative so aggregate demand is less
-reduction in growth
-increase in unemployment
-no demand pull inflation
-depends on size of deficit (% of GDP)
-Demand side factors arent as bad as supply side factors as supply side factors are usually long term and hard to solve
Consequences of a current account deficit
debt burden
countries that have a current account deficit often solve this by running a financial account surplus by issuing more debt and borrow from the rest if the world, selling gov/corporate bonds
when you keep racking up debt, people who lend you money lose confidence in you to pay it back
if investors pull out its more difficult to finance this current account deficit
more concerns means people will move money out of the country increasing the current account deficit more
by selling currency to move the money out of the country it reduces the value of the currency leading to a currency crisis, again hot money will leave the country depreciating the currency further resulting in an economic crisis
Consequences of a current account deficit
decreased exchange rate
could automatically correct a current account deficit but could lead to stagflation
expenditure reducing policies
contractionary fiscal/monetary policy
policies to reduce the amount of spending on imports in the economy
reduces aggregate demand and reduce incomes in the economy and reduce marginal propensity to import to close trade deficit
-raise intrest rates (monetary)
-reduce gov spending (fiscal)
expenditure reducing policies cons
-conflict of objectives (reduced growth, increased unemployment, possible recession), inflation could go below target rate
-consumer and business confidence could be so high that a decrease in AD has no effect on spending on imports
-output gap
-MPM
expenditure reducing policies(protectionism)
tarriffs, quotas, embargoes, domestic subsidies etc.
switch expenditure from imports to domestic goods
expendicture switching policies (protectionism) cons
-retaliation (could make CA deficit worse increase price exports)
-WTO rules (fines)
-inflationary
-higher prices
-loss of efficiency
expenditure switching policy (weaker exchange rate)
Weaken exchange rates for WIDEC
demand and expenditure for imports decrease
-reduce interest rates, hot money outflow more selling of currency and supply of currency increases so it depreciates
-increase money supply reducing exchange rate
-sell domestic currency reserves
expenditure switching policy (weaker exchange rate) cons
-marshall lerner condition, if PEDx + PEDm > 1then a weaker exchange rate wont improve a CA position but make it worse, but if not it can change elasticity in the long run - J curve
-inflation
-retaliation (currency wars)
supply side policies to boost international competitiveness
-price/quality competitiveness
-boost gov spending infastructure, education, subsidies to boost R+D
cut in tax, privatisation, deregulation etc.
makes domestic goods and services more competative making indicuals switch away from buying imports
supply side policies to boost international competitiveness cons
-time
-cost
-no guarantee of success
evaluation for policies to reduce CA deficits
-conflict of objectives
-cause of CA deficit
-time lags and costs
-is the CA really a problem
demand side causes of a CA surplus
- high incomes abroad, increased demand for exports
-low incomes at home, decreased demand for imports
-weak exchange rate (WIDEC)
