Disequilibrium in the Balance of Payments Flashcards
What reasons can a surplus be bad?
Inflationary Pressures
Exchange Rate Distortions
Global Imbalances
Resource Misallocation
How does a surplus cause inflationary pressures?
A sustained surplus means an excess inflow of foreign currency, which can increase domestic money supply leading to inflation
How does a surplus cause exchange rate distortions?
A large surplus leads to currency appreciation. Overvalued currencies harm export competitively causing more imports leading to trade imbalance
How does a surplus cause global imbalances?
Surpluses in a country may mirror deficits in others. This destabilises the global economy and causes tensions
How does a surplus cause resource misallocation?
Surpluses used by excessive saving or under-consumption indicates misallocation of resources and low domestic welfare
What is a disequilibrium in the balance of payments?
Where credit exceed debit or debit exceeds credit
What are the causes of a surplus in the balance of payment?
High Export Levels
Low Import Levels
Strong Remittance Inflows
High Income from Investments
Large Capital Inflows
Exchange Rate Policies
Favourable External Conditions
How do high export levels cause a surplus in the balance of payments?
Competitive Exports
Strong Global Demand
How do low import levels cause a surplus in the balance of payments?
Protectionist Policies and trade restrictions limit imports
Domestic Substitution means countries produce enough so rely less on imports
Weak Domestic Demand require fewer imports
How do strong remittance inflows cause a surplus in the balance of payments?
Income sent from working citizens abroad increase inflows leading to a surplus
How do high income from investments cause a surplus in the balance of payments?
Foreign Investment Returns from interest, dividends, or profits, increase income flows
How do large capital inflows cause a surplus in the balance of payments?
Foreign Direct Investment create surplus in the capital/financial account
Portfolio Investments from foreigners in financial assets boost the capital account
Loans or Aid from foreign lenders or international aid add to capital inflows
How do exchange rate policies cause a surplus in the balance of payments?
Undervalued currency makes exports cheaper
How do favourable external conditions cause a surplus in the balance of payments?
Global Commodity Prices may run surpluses due to high global prices
Trade Agreements boost export access to foreign markets
What are causes of deficit in balance of payments?
Population Growth
Development Programmes
Demonstration Effect
Inflation
Economic Growth
Recession in Trading Partners
Overvalued Exchange Rate
How does population growth cause a deficit?
To meet the needs of a growing population, it may require imports causing a deficit
How does economic growth cause a deficit?
Economic growth causes a rise in incomes, of which a proportion will be spent on imports
How do development programmes cause a deficit?
Developing countries need to import capital, raw materials. The development programmes behind this require imports
How does the demonstration effect cause a deficit?
People in less developed countries imitate consumption patterns of the people in developed countries, so their imports increase
How does inflation cause a deficit?
If UK inflation rises faster than competitors, UK exports become less attractive causing a deficit
How does a recession in trading partners cause a deficit?
Economic downturns in key trading partners reduce demand for UK exports
How does an overvalued exchange rate cause a deficit?
An overvalued currency makes a country’s exports more expensive and negatively impacts the trade balance
What are the 3 exchange rates?
Floating
Fixed
Managed/Dirty Floating
What are the floating exchange rates?
Floating exchange rates are flexible and those that are affected by demand and supply
What are fixed exchange rates?
Fixed exchange rates remain constant
What are managed/dirty floating exchange rates?
Managed/Dirty Floating exchange rates is were the central bank intervenes when necessary
What are the measures used to correct a deficit in the balance of payments?
Deflation
Exchange Depreciation
Devaluation
Exchange Controls
Tariffs
Quotas
Export Promotion
Import Substitution
How does deflation correct a deficit?
Deflation makes UK exports cheaper in foreign markets resulting in a rise in UK exports
Moreover, the demand for imports fall due to higher taxation and reduced income
How does exchange depreciation correct a deficit?
Exchange depreciation means decline in the rate of exchange. This stimulates exports and reduces imports as exports become cheaper and imports are more costly
How does devaluation correct a deficit?
Devaluation is the deliberate attempt made by monetary authorities
It has the same affect as exchange depreciation
How does exchange control correct a deficit?
Governments implement controls to restrict foreign exchange outflows. Policies can limit the amount of foreign currency people can access, reducing imports and encouraging domestic production
How do tariffs correct a deficit?
Tariffs are imposed on imports increasing their price and reducing their demand
How do quotas correct a deficit?
The government may fix and permit the maximum quantity and value of a commodity to be imported during a given period
How does export promotion correct a deficit?
The government promote export by providing required administrative and diplomatic help to tap potential markets
How does import substitution correct a deficit?
Import substitution reduces the volume of imports and make it self-reliant using fiscal and monetary measures to encourage industries
How do interest rates correct a deficit?
Raising interest rates means that borrowing becomes expensive, reducing demand and consequentially the demand for imports
What are the measures for correcting a surplus in the balance of payments?
Currency Appreciation
Boosting Domestic Consumption and Investment
Liberalising Imports
Reducing Capital Inflows
How does currency appreciation correct surplus?
Currency appreciation reduces export competitiveness and makes import cheaper
How does boosting domestic consumption and investment correct surplus?
Governments stimulate domestic demand through fiscal policies, increased public spending, tax cuts and encouraging consumers
How does liberalising imports correct a surplus?
Reducing barriers to import can increase inflow of goods and services, offsetting export surpluses
How does reducing capital inflows correct a surplus?
Governments can implement policies to limit capital inflows that add to financial account surpluses
