balance of payments continued Flashcards
what is hot money flows?
when foreign investors place their spare cash into the foreign banks that have the highest interest rates
what is the definition of FDI?
when an investment is made by a firm in one country into a firm in another country in order to gain control over the foreign firm and is recorded in the capital and financial account
what is hot money?
money that investors move internationally between banks to maximise the return they receive
how does the balance of payments always maintain a balance?
if there is a deficit on the current account then this must be balanced out by a surplus on the capital and financial account and vice versa
what are the factors affecting the current account?
exchange rate
relative inflation
productivity and costs
quality
growth
protectionism
SPICEE
strong pound
imports cheaper
exports
(more) expensive
what happens to a country if it has a high relative inflation in comparison to another?
if its inflation rate is higher than another’s than foreign firms may choose to buy their products because their imports would be cheaper which worsens the current account deficit
if a firm is productive and has a low cost per unit what does it mean for export prices? and if they had high costs per units?
low per unit cost —> low export price —> more competitive —> increase in demand for exports —> increase export revenue —> improve current account
high per unit cost —> high export price —> less competitive —> reduction in demand for exports —> decrease export revenue —> worsen current account
what happens if a countries quality is better?
higher quality exports —> sell more exports —> increase export revenue —> increasing the current account
what happens if a country experiences growth?
increase in exports —> increase in income —> increase importation of normal goods —> decreased importation of inferior goods
due to growth, what happens if a country imports more normal goods?
increased import of normal goods —> increased import expenditure —> more more leaking from the economy —> current account will decrease —> worsening the deficit
how does protectionism effect the current account?
decrease in imports (because of higher prices) —> fall in demand for imports —> increase in demand for domestic goods —> decrease in import expenditure —> improves the current account —> less money is leaking out of the circular flow
what is the most common cause of a current account deficit?
negative trade balance (because trade in g+s is the largest component of the current account)
what are government bonds?
a method of government borrowing
when do we have a balanced trade balance?
import expenditure is equal to export revenue
AD formula
AD = C+I+G+(X-M)
what happens if we increase the supply of pounds?
it will depreciate
chain of reasoning for a depreciation of the pound
increase in the price of imports —> decrease in the price of export —> increase in demand for exports —> increase in demand for pounds —> pound strengthens again
How is a worsening of the current account deficit most likely to affect aggregate demand and the exchange rate in the short run?
Aggregate demand will decrease and the exchange rate will depreciate
what are the three policies that can be used to reduce a current account deficit?
expenditure reducing
expenditure switching
supply side
what is the definition of expenditure reducing? what are the two main ways governments do this?
policies that get consumers to reduce their spending which will in turn reduce spending on imports which will improve the current account
raising income tax and cutting government benefits
what does raising income tax do? what does cutting benefits do?
increases income given to government —> less disposable income —> reducing spending on imports
people relying on benefits receive less money from the government —> less disposable income —> decrease in consumer spending —> less income expenditure
for both a decrease in spending means decrease in living standards
what is expenditure switching?
policies that get consumers to switch from buying imports to domestic goods
