Balance of Payments & Terms of Trade Task 2 Flashcards
What is Balance of Payments(BoP)
a record of all the economic transactions between the residents of Australia and residents of the world
Def of residents
individuals, businesses and govt
Def of transaction
when something of value is provided by one party to another
5 types of economic transactions and examples
1) export/imports of goods(e.g iron ore, PMV’s-cars)
2)export/import of services(eg education, tourism)
3) income flows - income paid/received on foreign investment(eg dividends, interest - payments)
4) transfers - when nothing of economic value is received in return (eg foreign aid, migrant funds)
5) financial flows - change in ownership of assets (eg purchase of shares,bans)
How does the ABS record transactions in the BoP?
Using a double entry accounting system - each transaction has an equal and opposite entry
- reflects the inflow and outflow of every transaction
Describe double entry accounting system
CREDIT(positive entry): money received into aus
Examples
- exports of g/s
- income received from foreign investment
- purchase of aus assets by foreign investments
DEBIT (neg entry): money flowing out of Australia
Examples
- import of g/s
- income paid to foreign investors
- purchase of foreign assets by aus residents
The BoP must sum to
ZERO as every transaction has a matching credit and debit entry
What are the 3 types of accounts that make up BoP
Current, capital and financial
What are the 4 types of transaction in Current Account
- Goods (credit/debit)
- Services (credit/debit)
- Primary Income (credit/debit)
- Secondary Income (credit/debit)
What is Goods C/D?
G Credit = Aus resident selling goods overseas aka merchandise exports.
- eg iron ore
G Debit = Aus resident purchasing goods from overseas, aka merchandise imports
- eg PMV’s
GC + (GD) = Net Goods (aka merchandise trade)
What is Services C/D?
S Credit = overseas resident purchases aus service
- eg education
S Debit = aus resident purchases a service from overseas
- eg tourism
SC +(SD) = Net services
What does net services and net goods = ?
(BOGS) Balance on G/S (aka trade balance)
- (+) = trade surplus
- (-) = trade deficit
What is Primary Income C/D?
PI Credit = aus resident earning income from overseas investment
- reflects the return on foreign investment
- eg divident payment
PI Debit = overseas resident earning income fro aus investment
- reflects the cost of foreign investment
- eg interest paid in overseas loan
PIC+(PID) = Net primary income
What is secondary income C/D?
SI Credit = aus resident receiving funds from overseas without providing anything of economic value in return
- eg migrant funds
SI Debit = aus resident providing funds overseas without receiving anything of economic value in return
- eg foreign aid
SIC+(SID)= Net secondary income
Net SI + NET PI = ???
Net income (aka income balance)
-(+) = income surplus
- (-)= income deficit
BOGS + Net Income = ???
Balance on current account
- (+) = current account surplus
- (-) = current account deficit
3 Types of transactions in capital and financial account?
Capital transfers C/D
Non produced, non financial assets
- disposal of NPNFA CREDIT
- acquisition of NPNFA DEBIT
Foreign investment flows
- foreign investment CREDIT
- aus investment abroad DEBIT
What is capital transfers C/D?
CT = refers to unrequited payments over 12 months
CT Credit = aus residents receiving funds from overseas without providing anything of economic value in return
- eg LT migrant funds
CT Debit = aus residents providing funds overseas without receiving anything of economic value in return
- eg LT foreign aid
CTC+(CTD) = Net capital transfers
What is Non produced, non financial assets (intangible assets)?
Assets: copyrights, trademarks, patents, blueprints
Disposal of NPNFA (CREDIT) = aus resident sells intangible asset overseas
-eg selling copyrights
Acquisition of NPNFA (DEBIT) = Aus resident purchases intangible asset from overseas
- eg purchasing trademarks
Disposal of NPNFA + (Acquisition of NPNFA) = net disposal/aquisition of NPNFA
Net capital transfers + net disposal/aquisition of NPNFA = ???
Balance on capital account
What are foreign investment FLOWS? and 4 types
represent a change in ownership assets between residuals and non residents
1) direct Investment (10% or more ownership of the asset)
2) portfolio investment (less than 10% ownership of the asset including 0% eg laws)
3) govt debts/loans
4) reserve assets eg gold, currencies
What is Foreign invesment C/D
FI Credit = overseas resdient purchasing an aus asset
- FI into aus
- aka foreign liabilities
- eg selling of aus shares
Aus Investment abroad Debit = aus residuals purchasing an overseas asset
- FI flows out of AUS
- aka foreign assets
- eg loan overseas
FI + (AUS Inv Abroad)= Balance on Financial account
Balance of capital account + balance on financial accounts =???
balance on the capital and financial accounts
- (+) = capital and financial account surplus
- (-) = capital and financial account deficit
What is net errors and omissions?
NET ERRORS = difficult to record every transaction accurately
OMISSIONS = items which are missed
Balance on current account + Balance of capital account & balance on financial accounts + net errors and omissions = ???
ZERO
Long term trends in Current accounts
Historically, Aus recorded a CAD (44 years up until 2019)
WHY?
- aus records large net income deficits
- receives foreign investment to fund mining industry and eco growth
- this is eventually paid back in form of dividends and interest payments (outflow on debit in primary income)
Recent trends: 2019 CAS
Aus recorded first CAS in 44 years in 2019
WHY?
- driven by trade surpluses
- high demand for iron ore from china
- Chinese govt attempting to stimulate economy through constriction/manufacturing sector (Requires iron ore)
- simultaneously, mine in brazil collapsed which reduced world supply of iron ore
- increases quantity of aus exports as well as price of them (commodity prices)
4 Overall patterns In Current Account?
- trade balance is highly volatile - fluctuates between a surplus and deficit depending on domestic/world economic activity
- trade balance and current account balance have a strong positive relationship ie TB ↑, CAB↑
- Aus net income balance is consistently in deficit due to primary income account
- in recent years, aus has invested more abroad than it was received in form of foreign investment
What does Aus historically rely on as a source of eco growth?
Foreign Investment
What is Aus top 3 sources of investment
UK, US, JAPAN
What does Foreign investment include?
- purchase of shares
- loans property
- govt bond
- multi national companies opening overseas branches
- used to develop new and existing industries eg mining and agriculture
- aus relies on FI due to savings investment gap
AUS Savings
Aus has similar savings rate to others OECD nations
- aus has relatively small population and cannot raise enough funds for required investment
4 reasons why does Aus attract FI?
- interest rate differential
- stable govt and legal system
- investment opportunities
- strong econ growth
Impact on SI gap on BoP
CAB = diference in a countrys savings and investment
When a countrys S<I: it will have a current account deficit (financial acct surplus)
- it will borrow funds from overseas investors in the form of foreign investment
When a countries S>I: it will have a current account surplus (financial account deficit)
- it will ‘lend’ the difference overseas in the form of aus investment abroad
Up until in 2019: investment exceeded savings in aus, resulting in CAD
- in 2019 a rise in savings and fall in investment resulted in CAS
Terms of trade definition
indicates the amount of imports that can be obtained with a given amount of exports
Terms of trade index and equation
measures the movement of export prices relative to import prices
(Index of avg export price/index of avg import price) x 100
What does the price index measures?
the movement of prices over a period of time
definition of index of avg export prices
XPI
- rate of change overtime in the prices of exported goods
definition of index of avg import prices
MPI
- rate of change overtime in the prices of imported goods
2 reasons why ToT is important?
if ToT rises (favourable movement) - export prices rise relative to import prices
- more imports can be purchased with a given volume of exports
- improves standard of living
if ToT falls(infavourable movement) - exports prices fall relative to import prices
- less imports can be purchased with given volume of exports
XPI formula
total price exports current year/total price exports base year
MPI formula
total price imports current year/total price imports base year
3 Aus ToT trends from mid 2000’s to 2011
- ToT boomed, driven by a rise in commodity prices
- countries such as china were developing rapidly and needed steel for housing, transport, infrastructure, factories
- less to high demand for aus exports (iron ore, coal, gas)
3 Aus ToT trends from 2011 to 2016
- growth in china slows, leading to a decrease in demand for aus commodities
- at the same time, aus mining industry moved from construction to production phase - increasing supply of commodities
- this puts downward pressure on commodity price and ToT
3 Aus ToT trends from 2016 to 2021
- strong global growth leads to rise in ToT and commodity prices
- as economies recover from COVID, this has led to further demand from commodities (Eg Chinese govt investing in construction and manufacturing sector)
- supply disruptions due to russian - ukraine war have also caused countries to look to aus for alternative energy and food sources
3 Causes of microeconomic changes in ToT
- Australia’s export price index is dominated by commodity prices, which are particularly prone to fluctuations.
- For eg, an increase in the supply of iron ore and a fall in demand for iron ore in 2014-15 led to a fall in the price of iron ore.
- Australia, as a major exporter of iron ore,experienced a fall in their terms of trade as a result of the commodity price fall.
4 reasons Why demand might change for a specific export or import product?
- Change in price, quality, or availability of a substitute product
- Change in incomes
- Change in tastes/fashion
- Change in population
4 reasons Why supply might change for a specific export or import product?
- Change in protectionism police (e.g. change in tariff)
- Change in a Free Trade Agreement
- Change in technology (e.g. shale oil)
- Change in climate & natural disasters (e.g. agricultural products
Causes of macroeconomic changes in ToT
- The overall rate of inflation in a country relative to inflation in other countries may change because of shifts in aggregate demand and/or aggregate supply.
- eg, if inflation in Australia is relatively high compared to inflation elsewhere, other things being equal, the price of Australian exports will increase faster than the price of imported products bought by Australians, and the terms of trade will improve.
8 effects of ToT on econ activity
(C+I+G+(X-M))
- ↑ in ToT due to higher commodity prices leads to an expansion in econ activity
- firms look to expand production, triggering an increase in investment (eg mining industry)
- also creates increased demand for workers in export related industries(eg mining, construction, engineering)
- results in an ↑ in employment and wages
- in turn, this support an ↑ in h/h income and consumption
- increased profits for mining companies leads to ↑ in govt revenue
- overall, AD rises boosting growth even further
- downside-can create inflationary pressure
2 effects of ToT on living standards
- when there is a favourable movement in ToT, a country can obtain more imports with a given number of exports
- this raises purchasing power as more g/s can be accessed across population, living standards rises
3 effects of ToT on trade balance
- ToT measures changes in the price of exports/imports, whereas trade balance measures change in the value of exports/imports (accounts for both price and quantity)
- these show a positive relationship - rise in ToT leads to increase in trade balance
- 2022- aus recorded its highest trade surplus as a result of a record high ToT
3 effects of ToT on exchange rate
- movements in ToT also directly impact ER(value of one current in terms of another)
- a strong ToT will likely lead to an appreciator (rises) of the ER
- high export prices lead to more demand for aud, boosting its value
GRAPH Rise in ToT - exports
- S(f) establishes PW above EQ
- rise in ToT means export prices RISE relative to import prices (PW to PW’)
- prod surplus increases due to higher price and rise in size of exports
- TS rises (shown by gains on graph)
GRAPH Rise of ToT - imports
- S(f) = PW below EQ
- rise in ToT measn imports can be obtained at a LOWER price relative to exports (PW to PW’)
- CS increases (shaded area) as consumers can purchase more imports at a lower price
- TS overalls increases (shown by gains)
9 Factors affecting Current Account
- domestic growth
- world growth
- world commodity prices
- terms of trade
- exchange rates
- relative inflation rates
- interest rate differential
- level of domestic savings
- supply shocks
What is 4 affects domestic econ growth can have on CAB
- When domestic activity increases, both investment and consumption increase.
- Investment requires imported capital goods (e.g. machinery).
- Increased consumption also increases import of final consumer g/s.
- Overall trade balance (TB) likely declines, Current Account Balance (CAB) decreases.
what is 2 affects world econ growth can have on CAB
- When economic activity of a trading partner increases (e.g. China): this increases the demand for Australia’s exports.
- Overall TB likely increases, CAB increases.
what is 5 affects exchange rates can have on CAB
- ER refers to the value of one currency in terms of another
- ERs affect the quantity of exports and imports
- Depreciation of the ER = a fall in currency’s value.
- Makes exports cheaper (X rises) and imports more expensive (imports fall).
- Overall TB likely increases, CAB rises.
what is 2 affects world commodity prices can have on CAB
- When world commodity prices are high, countries that specialize in commodities see an increase in export revenue.
- Overall TB likely increases, CAB increases.
what is 6 affects terms of trade can have on CAB
- ToT Index: measures the movement of export prices relative to import prices.
- Favourable movement -> export prices rise relative to import prices.
- Export revenue increases therefore overall TB increases, CAB increases.
- Unfavourable movement -> export prices fall relative to import prices.
- Export revenue less compared with an increase in the cost of imports.
- Overall TB declines, CAB decreases.
what is 2 affects inflation rate can have on CAB
- When Australia’s inflation (prices) is relatively higher than abroad: this reduces the competitiveness of exports.
- Overall TB likely declines, CAB decreases.
what is 2 affects interest rates can have on CAB
- If IRs are relatively higher in Australia than abroad: this attracts foreign investment to Australia as the return on investment is higher.
- Creates inflows in financial account therefore Financial Account Balance increases, Primary Income Deficit grows.
what is 1 affect level of domestic savings can have on CAB
- When S < I: Current Account records a deficit (Financial Account Surplus) as gap is borrowed from overseas.
(basically impact of SI on BoP)
what is 1 external shocks can have on CAB and one example
- Supply shocks refer to an unexpected event which suddenly increases or decreases the supply of a g/s or commodity.
- E.g. 2019 -> Brazil mine collapse decreased the global supply of iron ore and drove up world commodity prices, creating trade surplus for Australia.
BOP stuff bc i keep forgeting
if CR decreases and DR increases = CAB decreases and vice versa
