Balance Of Payments Flashcards
Define balance of payments
A record of the country’s transactions with the rest of the world- consists of the financial and current account
X-M=0
what is it called if the value of imports is greater
A BOP current account deficit
what is it called if the value of exports is greater
A BOP current account surplus
what is the current account
Measures transfers in assets and liabilities
how to work out current account
balance of trade in goods + balance of trade in services + net income/primary flows + net current transfers/secondary income flows
what is primary income
wages
investment incomes
income received on FDI
what is secondary income/current transfers
a transaction representing ‘something for nothing’
remittances
factors affecting BOP
economic growth/consumer spending
exchange rate
decline in international competitiveness
overvalued exchange rates
what does the capital/financial account do
measures transfers in assets and liabilities
examples of capital/financial account
direct investment (building factories) currencies held by central bank other investment (housing)
if a country has a current account deficit…
it will have an equivalent capital account surplus
this is necessary to finance a current account deficit
Overall balance of payments =
current account + financial account + capital account = 0
what is a BOP imbalance
when trade between countries is too one sided over a long period of time
how can natural short run imbalances be solved
by exchange rate movements
WPIDEC
what can a long term BOP current account deficit cause
structural unemployment
what can a long term BOP current account surplus cause
lower standard of living- if wages are kept low, value of currency kept low, so exports cheap, but imports expensive
Why is a BOP current account deficit considered harmful to the economy
Lowers AD
Must run a surplus on financial/capital account- foreigners have a claim on your assets
May seem uncompetitive, lower growth of exports
Loss of confidence- devaluation, lower living standards
Main causes of structural trade surpluses (opposite for deficits)
Export orientated growth Foreign Direct Investment Undervalued exchange rate High domestic savings rate Closed economy Strong investment income from overseas (U CHEFS)
Negative consequences of a current account surplus
Weak domestic demand- lower consumer spending and lower spending on imports
Domestic unemployment suffers
Why is the current account cyclical
Boom: current account deficit rises, consumer spending rises, increasing imports, unemployment falls and inflation rises.
Recession: consumer spending falls decreasing imports, lower inflation, improvement of current account, higher unemployment
Ways to influence BOP current account
Tariffs Quotas Exchange rate adjustment (short run) Deflationary demand management (short run) Import restrictions (short run) Supply side policies (long run)
What is an exchange rate adjustment
Reduces exchange rate, if currency price is too high, by selling currency or reducing interest rates
Increases competitiveness
Import prices rise export prices fall
What does exchange rate adjustment depend on
Demand for exports/imports must be elastic
Retaliation
Increases AD, but inflationary pressure may result
What is deflationary demand management
Discourages expenditure on imports by adopting deflationary fiscal and monetary policy
Reduces consumer spending power
Fall in AD and increases unemployment
