Chapter 3 - Balance of Payments Flashcards
Balance of Payments
Record of all financial transactions made between countries, businesses and government in one country with others
Outflows
Exports
Positive entry
Inflows
Imports
Negative entry
Current account
Balance of trade in goods and services
Net primary income
Net secondary income
Capital account
Transfer of funds associated with buying fixed assets
(small)
Financial
FDI - investment from abroad
Portfolio investment - savings, bonds
Hot money flows
Current + capital
Show whether the economy is a net leander to the rest of the world, or a net borrower to the rest of the world
It is equal to the financial account
BOP Deficit
Imports > Exports
Causes of deficits
Low productivity - not internationally competitive
High inflation rate
Overvalued ER
Dependency on highly priced imported materials
Relocation of industries in low wage countries
Protectionism in other countries
BOP Surplus
Exports > Imports
Causes of surplus
High productivity - internationally competitive
Low inflation rate
Undervalued ER
Abundance of highly priced exported materials
Relocation of industries from high wage countries
Protectionist policies designed to reduce imports
Policies to reduce a current account deficit
Devaluation of the ER
Demand side policies
Supply side policies
Devaluation of the ER (to reduce a CAD)
Make exports cheap and imports expensive
- Decrease imports and increase exports - improvement
EVAL: depends on the elasticity of exports and imports
- Marshall Learner condition - only works if PEDm and PEDx > 1
- J curve: time lags and links elasticity and current account -> demand in the short run is more inelastic
SUBEVAL:
- Can lead to imported inflation - cost push inflation
- Depends on inflation
- Depends on consumer spending
Demand side policies (to reduce a CAD)
Reduce AD and inflation - tightening monetary and fiscal policy
Monetary policy
- Increase the IR - increase cost of debt, decrease consumption of imports and exports become more competitive
EVAL: hot money flows lead to an appreciation
Fiscal policy
- Increase income tax - decreases disposable income - decreases spending on imoprts
EVAL: a fall in AD will lead to a rise in unemployment
Supply side policies (to reduce a CAD)
Improve the competitiveness of an economy and make exports more attractive
- Education
- Training
- Privatisation
EVAL: takes a lot of time to have an effect
Other policies to reduce a CAD
Lower wages - decrease COP, so improve competitiveness - internal devaluation
- EVAL: a fall in AD will lead to deflation
Protectionism
- EVAL: retaliation
Export reducing
Decrease demand, thus decreasing spending on imports
Export switching
Switch consumer spending towards domestic goods rather than imported goods
Why do CADs and CASs not matter?
CAD may be the result of an increase in economic growth
CAD and a surplus in the capital or financial account is OKAY
CAD only matters if it is a large percentage of a country’s GDP
Exchange rates
The rate at which one currency trades against another on the foreign exchange market
Floating exchange rates
The value of the currency is determined by the market forces
Fixed exchange rates
Government or central bank seeks to keep the value of a currency at a certain level
Managed exchange rates
Market forces determine the value, which is calculated and set by the central bank
Revaluation
Fixed exchange rates
- Government or central bank increase the value of the currency
Appreciation
Floating exchange rates
- Value of the currency increases
Devaluation
Fixed exchange rates
- Government or central bank decrease the value of the currency
Depreciation
Floating exchange rates
- The value of the currency falls
Foreign currency transactions (government intervention in ER)
Involves the central bank buying or selling a currency
- Increase the value by buying their own currency, which decreases the supply and increases the price
Interest rates (government intervention in ER)
Cost of borrowing, and the reward for saving
- An increase in IR leads to hot money flows, which increase demand for the currency and thus appreciate it
Hot money flows
Short-term investments that move swiftly between different countries or financial markets in search of higher returns.
Quantitative easing (government intervention in ER)
Central bank buys financial assets in exchange for money to increase borrowing and lending
- Means there is less money supplied, so the value rises
Factors affecting ER
- Inflation - low inflation leads to stronger currencies - more countries will import their products - increase demand of their currency
- IR - high IR = increase local currency rates
- CAD - CAD is higher than that of a trading partner, this can weaken its currency relative to that country’s currency
Competitive devaluation
One country strategically devaluates its currency
Can negatively impact trading
Impact of changes in exchange rates
CAD
Economic growth and unemployment
- ER appreciates: AD falls
- ER falls: increase exports
Inflation
- Depreciation of ER = inflationary
FDI
- Depreciation = wages and COP fall = country is more internationally competitive, which increases the likelihood of FDI
International competitiveness
The ability of a country to compete in international markets
How to measure international competitiveness
- Relative productivity rates - output/hour
EVAL: only takes into account one factor, it is thus better to use multifactor productivity rates - Relative unit labour costs - total wages/real output
- RUI increase - country is less internationally competitive - Relative export prices
- REP increase - country is less internationally competitive
Factors influencing competitiveness
- Productivity increases - increase in international competitiveness, due to a decrease in unit labour costs
- Quality of human capital increases, thus productivity increases, which decreases labour costs, which increases competitiveness
- ER falls - increase competitiveness
Policies to increase international competitiveness
Education and training
Investment incentives - subsidies/decreasing tax or IR
Privatisation and deregulation - increase or decrease barriers to entry
Depreciating ER - export prices fall which increases competitiveness
Trade liberalistion
Taxation
Benefits of international competitiveness
Increased exports
Job creation
Higher standards of living
FDI
Problems of international uncompetitiveness
Trade deficits
Economic decline
Unemployment
Income inequality
