Balance of payments pt2 Flashcards
Long term direct capital flows
Describes foreign direct investment in which a company acquires real productive assets in another country. This may happen y setting up, merging with or taking over a company based in that country
Portfolio capital flows
Describes investment in financial assets abroad. It is common for financial institutions in one country to buy shares or government bonds from foreign countries. The 2008 financial crisis slowed down as investors confidence in the assets they were buying collapsed
Short term “Hot money” capital flows
Both direct and portfolio investment are medium to long term investments through the international movement of money. Some firms have a shorter term strategy by moving money between currencies, hoping that one gets stronger so they can convert it back and make profit.
Hot money expoits
Hot money looks to exploit the exchange rate, looking for countries where interest rates are high. The volume of currency speculation and hot money flows has increased which creates dangers of self fulfilling prophecies and economic destabilisation
Self fulfilling prophecy
Where exchange rates float freely, an excess of demand causes exchange rates to rise. So a mass move by investors to buy a currency in anticipation of a rate rise will cuse the rate to rise
Destabilising effects
Large movements of hot money in or out of a given currency affects the exchange rates and as a result affects trade, the current account and the economy as a whole. Governments have little to no control over investors and limited means to defend their currency
Policies to tackle a BOP deficit
Deflation-Contractionary monetary or fiscal policy with the aim of reducing AD
Direct controls-Import controls such as quotas, tariffs and regulations
Devaluation-Exchange rates lowering, depreciation
Deflation-Expenditure reducing policies
Direct controls and devaluation-Expenditure switching policies
Trying to rebalance trade by getting people to spend less on imports
Deflation (expenditure reduction policy)
Deflationary policies reduce AD. The effect on imports will depend on the marginal propensity to import. The higher the MPM, the greater the impact of this sort of policy. Can act as an expenditure switching policies as lower inflation means cheaper domestic products compered to overseas.
MPM example
If the Marginal propensity to import is 0.55 and AD falls by 10B, this means there is a reduction in spending imports by 5.5B
Direct controls
It acts to switch spending from homegrown to imported goods. Individual governments have only limited powers in this regard due to existing trade treaties and membership of organisations such as the EU and the WTO. Such policies reduce welfare and do not deal with the reasons why domestic product cannot compete on a level playing field with imports
Currency devaluation/depreciation
When our currency buys less of another currency than previously, imports become less attractive, while our exports enjoy a price competitive advantage over other countries goods.
