Chapter 13 Flashcards
Defn. Balance of payments (BOP)
a comprehensive record of the country’s international receipts and international payments between the residents and govt of a country and the rest of the world, over a period of time, usually a calendar year
credits, debits, receipts, payments
- receipts of money from abroad are regarded as credits and are entered in the accounts with a positive sign. these items result in the rise in foreign exchange (ie. inflow of money and outflow of goods and services) like export rev concept?
- payments of money abroad are regarded as debits (like debt so payment) and are entered in the accounts with a negative sign. these items result in the fall in foreign exchange (ie. outflow of money and inflow of goods and services) like import expend concept?
Current account
records receipts and payments. comprises of sub-accounts:
- Visible trade (goods)
- Invisible trade (services like shipping transportation travel govt expend. etc.)
- Unilateral transfers (like donations to other countries in times of crisis)
- income flows
- interest is earned on loans to foreign govt or institutions and on deposits in foreign banks
- profits are received (credits) from companies owned abroad and dividends that arise from holding shares in foreign companies
*largest component of current account is the balance of trade (comprises of visible and invisible trade)
Capital and financial account
records the flow of funds into and out of the account and is associated with changes in ownership of assets. categorised into:
- short-term capital inflows
- hot money - long-term capital inflows
- foreign direct investments (changes to the acquisition or sale of assets eg a factory or a farm or the takeover of a whole firm)
- portfolio investments (changes in the holding of paper assets, such as company shares and the buying of foreign bonds)
BOP equilibrium
international payments equals to international receipts
- no BOP surplus or deficit
Causes of BOP deficit or worsening BOP: current account
- rise in M and/or fall in X due to rise in demand for imports or a fall in price of imports, fall in demand for exports, rise in price of exports
- graph
- loss of export competitiveness due to the emergence of low cost competitors
- relatively higher domestic inflation rates
- higher domestic income and increased access to credit
- trading partners depreciate their currencies
- trading partners under-value their currencies
Causes of BOP deficit or worsening BOP: capital and financial account
- rising COP or emergence of low-cost producers
- fall in relative interest rates
Implications of a BOP deficit or worsening BOP
- falling real income and rising unemployment
- falling future living standards
Measures to correct a persistent current account deficit or worsening current account: expenditure-reducing policies
expenditure-reducing policies (to decrease demand for imports)
- involve reducing the level of expenditure on imports which can be brought about by contractionary monetary (increase interest rates to decrease consumption and investment expenditure) and fiscal policies
- leads to a fall in GDP and hence fall in demand for imports. the fall in demand for imports leads to fall in M and this improves the trade deficit and hence the current account and the BOP
*the use of contractionary policies is ONLY exercised when the country is already facing an overheating economy. this helps to reduce overheating as well as address the worsening BOP
Evaluation of Measures to correct a persistent current account deficit or worsening current account: expenditure-reducing policies
+:
- these policies reduce the domestic inflation rate relative to those in other countries hence improving the export price competitiveness and export revenue
- demand for imports is also dampened as incomes are reduced
- a tight monetary policy will raise the i/r which will attract short term foreign funds (hot money) into the country which will improve the capital balance
-:
- when the demand for exports is price inelastic and the demand for imports is income inelastic, the effect of the policies will be minimal and will have minimal impact on M and X
- the fall in demand for other countries’ exports may cause them to face falling incomes and employment levels eventually causing the demand for the domestic country’s exports to fall
- there is also a conflict between internal and external policy goals (i.e. achieving full employment at home versus achieving a balance of payments equilibrium) this is because contractionary policies will reduce real income and create unemployment
Measures to correct a persistent current account deficit or worsening current account: expenditure-switching policies
involve the use of exchange rates (depreciation), and protectionism to induce both local and foreign economic agents to switch away from foreign produced to domestically produced goods. this can be achieved by making imports relatively more expensive and exports relatively cheaper
- tariffs
-> raise price of foreign products as they enter the country and make imports less price competitive than local products - subsidies
-> making domestic goods and exports relatively cheaper - depreciation
- other measures - lowering cost and raising productivity
measures to correct a persistent capital and financial account deficit or worsening capital and financial account
Contractionary MP
-> raise i/r to encourage hot money inflow
Encourage FDI
-> lowering corporate income tax (FP)
-> provide tax holidays to foreign firms
Others
-> raising lab productivity, building better infrastructure, R&D grants
causes BOP surplus or improvement in the BOP
Opposite of deficit
- improvement of the current account
- gain in export competitiveness
- relatively lower domestic inflation rates
- higher import consumption of trading partner
- trading partners’ currencies appreciate
- worsening of the TOT (terms of trade) - improvement in the capital and financial account
- lowering COP or rising productivity that raises FDI
- a rise in relative rates - attracts hot money
implications of rising real income and falling Un
- rising real income and falling unemployment
- possibility of inflation
measures to reduce a BOP surplus in the current account
- expenditure-switching
- expenditure-raising
reverse of above
