Global Economis- Balance of Payments Flashcards
Define Balance fo Payments
The balance of payments is a record of the value of all transactions between the residents of one country and the residents of all other countries in the world over a given period of time.
BoP = Current account + Capital account + Financial account = 0
What is the current account?
A record of transactions in exports, imports and income flows between one country and the rest of the world over a given period of time
What is the capital account?
A record of all the transfers of ownership of capital and other assets between countries.
What is the financial account?
The financial account is a record of all financial transactions and direct investments between countries, and currency reserves held by central banks
What are the components of the current account?
1- BALANCE OF TRADE IN GOODS
This is the visible balance, where tangible goods are traded between countries
2-BALANCE OF TRADE IN SERVICES
This is the invisible balance, consisting of the balance of trade of legal services, hospitality, consultancy, and so on.
3-INCOME
Income refers to the factor payments for the factors of production. (if you own factor of production abroad)
4-CURRENT TRANSFER
refers to a payment between one government and another that is not in exchange for any good or service. (An example is foreign aid.)
When do we have current account deficit and current account surplus?
if :
Balance of trade of goods + Balance fo trade of services + income + current transfer
<0 CURRENT ACCOUNT DEFICIT
>0 CURRENT ACCOUNT SURPLUS
What are the components of the capital account?
1-CAPITAL TRANSFER
A capital transfer is a transaction relating to the transfers of ownership of fixed assets, transfers of funds linked to the buying and selling of fixed assets, or debt forgiveness.
2- TRANSACTION IN NON-PRODUCED, NON-FINANCIAL ASSETS
Non-produced assets largely cover intangibles, such as patented entities, leases or other transferable contracts, and payments of goodwill.
(A lends money o B, A registers monay as credit, B register money as debit)
What are the components of the financial account?
1-FOREIGN DIRECT INVESTMENT
The long-term investment by multinational corporations in a foreign country (usually more than 10%)
2-PORTFOLIO INVESTMENT
purchasing and sales of financial capital (this is ONLY the transaction, not the income earned in the future, that is in the current account)
3-RESERVE ASSETS
These are foreign currencies reserves held by central banks. (paper money, deposits, government bonds)
4-OFFICIAL BORROWING
Official borrowing occurs when the government borrows (debit) or lends (a credit item) money from IMF, world bank of other governments
What is the relatinship between the current and financial account?
The current account and the capital and financial accounts are interdependent. A change in one account will cause an opposite, but equal, change in another
Define current account surplus
revenue arising from the sale of exports, inflowing income and transfers is greater than funds flowing overseas to pay for imports, outgoing income and transfers.
THIS WILL LEAD TO APPRECIATION OF THE CURRENCY
Define Current Account deficit
when the expenditure by a country on imports, outgoing income and transfer of money out of the country is larger than the money arising, from imports, inflowing income and transfer.
THIS WILL LEAD TO DEPRECIATION OF THE CURRENCY. (causes downward pressure on the currency of the country)
What are the implications of a persistent account deficit?
- Depreciation of the currency (Cost-push inflation)
- Possible need for higher interest rates to attract foreign financial investment, leading to recession
- Increased sale in domestic assets to foreigners
-Increased borrowing from abroad
-poor international credit ratings
-cost of paying interest loans
-fewer imports of needed capital goods
other than resources
-lower standards of living in the future
-increasing higher interest rates
- Painful demand management policies (contractionary fiscal policies
- Lower economic growth in the future
What are the methods to reduce current account deficit?
- Expenditure reducing policies (contractionary fiscal and monetary policiesto reduce AD)[it depends on the amount of spare cpacity in the economy. if the economy is at full employmetn level of output, then contractionary methods are applicable, however too much of it would cause the economy to fall in a recession]
- Expenditure switching policies (trade protection, Depreciation) [depends on the elasticity of the demand curve]
- Supply side policies to increase competitiveness (market oriented, interventionist to improve human capital) [it is particularly effective in the long-run since it improves efficiency and competitiveness of both exports and domestic goods]
What is the Marshall-lerner condition?
The Marshall–Lerner condition describes the circumstances under which a depreciation of the domestic currency will lead to an improvement into the current account.
It states that a depreciation will only lead to an improvement in the current account if the sum of the elasticities of a country’s exports are greater than 1
What does the J-curve shows?
The J-curve describes what happens to the current account when a currency depreciates. In the short run, a depreciation may lead to a worsening of the current account. However, in the long run the current account will improve and lead to a current account surplus.
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