International Flashcards
What are the three components of the Balance of Payments?
- Current account balance
- Financial account balance
- Capital account balance
What three components make up the current account balance?
- Balance of trade in goods and services
- Primary income flows (profits, dividends and interest payments)
- Secondary income flows (gifts of money, charity, overseas aid and contributions to bloc budgets)
What are the three key factors affecting the current account?
- Productivity (affects price competitiveness)
- Inflation relative to trading partners/ competitors
- Exchange rate (SPICED)
What is an inward primary income flow?
The profits flowing into the country from a domestic MNC that has set up abroad.
What are the three components of the financial account balance?
- Direct investment
- Portfolio investment (bonds and shares)
- Speculative hot money flows
Define FDI.
The investment in capital assets, such as manufacturing and serve industry capacity, in a country by a business with headquarters in another country.
Establish the link between primary income flows and capital flows.
Outward capital flows generate inward primary income flows in subsequent years (and vice versa).
List three benefits of capital flows.
- Facilitates growth in world trade.
- Provides capital for firms that would have been unable to secure finance within their own countries.
- FDI can lead to the transfer of technology and information between countries.
List three drawbacks to capital flows.
- FDI can lead to national firms becoming owned by overseas firms (change in objectives).
- Availability of international credit may lead to overborrowing by firms and government.
- One country’s financial system becomes vulnerable to the global financial system.
What is the ‘net errors and omissions’ balancing item used for?
Correcting errors, delays and omissions from the balance of payments account to bring it to zero.
How can governments finance a current account deficit?
- Increase the level of borrowing abroad.
- Take out savings and investments held abroad.
Able to borrow abroad as long as foreign lenders think the loans will be repaid with interest.
When does a balance of payments crisis occur?
When the inward flow of capital needed to finance a current account deficit abruptly halts. Usually reflects foreign creditors’ doubts regarding the likelihood of full and timely repayment.
Why might a trade deficit be damaging?
- Could indicate a lack of productivity.
- A surplus on the financing section increasing international indebtedness.
- Deflationary pressure with lower AD.
- Could indicate structural weaknesses.
- May lead to or be a result of unemployment.
Why might a trade deficit be a good thing?
- Reflection of rising living standards.
- Not problematic if can finance relatively easily.
- Deficit may be due to capital goods imports, which will lead to future productivity and growth.
- May only be temporary.
- May only be a small % of GDP.
What are the benefits to a current account surplus?
- Sign of competitiveness.
- Increased AD.
- Positive multiplier effects.
- Higher employment.
What are the drawbacks to a current account surplus?
- Higher demand pull inflation which is problematic if close to full capacity.
- Reduces what is available for consumption now by domestic consumers (opportunity cost).
- Can cause friction between countries - can only reduce a deficit if another country reduces its surplus.
What are the two types of policy that attempt to reduce a current account deficit?
- Expenditure reducing: reduce demand for imports by reducing AD.
- Expenditure switching - switching domestic demand away from imports to domestically produced goods.
Outline the Marshall Lerner Condition.
When the sum of export and import elasticies is greater than unity (ignoring the minus sign), a fall in the exchange rate can reduce the deficit and a rise in the exchange rate can reduce a surplus.
Outline the J-Curve effect.
In the short run, demand for imports and exports tends to be price inelastic as firms/ consumers take time to respond to changes in price. Therefore, the current account position may worsen in the short run before improving.
Why might the J-Curve effect be short lived?
- Increased import prices will raise the country’s inflation rate.
- Initial worsening of BoP may reduce confidence, which leads to capital outflows that destabilise BoP and exchange rate.
How does automatic correction fix a deficit?
If imports > exports, pounds are being sold so supply increases. Currency depreciates, making exports cheaper and imports more expensive.
What is a currency pair? (e.g. GBP/ USD)
The quotation of two currencies, with the value of one being quoted against the other. The first listed currency is called the base currency and the second is called the quote currency.
Define the effective exchange rate.
Calculations of the average movement of the exchange rate, usually weightings determined by the value of trade undertaken with a country’s main trading partners.
Define the real exchange rate.
The weighted average value of a country’s currency relative to a basket of other major currencies, adjusted for the effects of inflation. It measures competitiveness.
List the 4 types of exchange rate systems.
- Freely floating
- Dirty floating
- Adjustable peg
- Fixed
Define the freely floating exchange rate.
An exchange rate solely determined by supply and demand for that currency.
Define the dirty floating exchange rate.
The exchange rate will float freely but the government/ central bank may occasionally intervene to change the value of the currency.
Define the adjustable peg exchange rate.
The rate at which the exchange rate is fixed may be changed from time to time by devaluating or revaluating the currency. There is usually a band which the exchange rate is allowed to fluctuate in.
Define the fixed exchange rate.
The exchange rate is fixed at a certain level by the country’s central bank and maintained by its intervention in the foreign exchange market.
What is the difference between devaluation and depreciation?
- Devaluation: value of the currency officially falls.
- Depreciation - value of the currency falls because of free market forces or with a dirty float because of government intervention.
State the three key determinants of floating exchange rates.
- International trade in goods and services needs to be financed.
- Long term capital movements.
- Speculation in foreign exchange markets.
List 4 causes of an appreciation.
- Trade flows (increased demand for exports).
- Net inward investment.
- Speculative movements.
- Higher interest rates compared to other comparable countries.
List the 6 advantages of a freely floating exchange rate.
- Automatic adjustment (corrects BoP current account disequilibrium).
- Responds to changes in competitiveness/ comparative advantage.
- Frees up the government to deal with other objectives.
- Frees up monetary policy.
- Less need for foreign currency reserves.
- Speculative attacks on a currency are less likely.
List 3 disadvantages of a freely floating exchange rate.
- International trading uncertainty
- Exchange rate is vulnerable to speculation and capital flows
- Can fuel inflation
What is the aim of a managed exchange rate?
Achieve stability and certainty with the ability to avoid under or over valuation.
List 2 advantages of fixed exchange rate.
- Provides certainty and stability
- Provides strong anti-inflationary discipline
List 5 disadvantages of a fixed exchange rate.
- Prolonged over or under valuation of currency.
- Possible BoP crisis if currency is overvalued.
- Overvalued currency can have deflationary costs of low output and high unemployment.
- Tying up resources in official reserves.
- Susceptible to speculative attacks.
List 3 benefits of a currency union.
- Certainty of prices
- Price transparency
- No conversion costs
List 5 disadvantages of a currency union.
- Loss of control over monetary policy
- A greater reliance on fiscal policy to stimulate the economy
- Stronger economies have to support weaker ones if problems occur
- The importance of joining at the right exchange rate
- Loss of competitiveness for domestic firms
State the four convergence criteria for a monetary union.
- Price stability
- Sound and sustainable public finances
- Durability of convergence
- Exchange rate stability
State the 4 main criteria for an optimal currency area.
- High labour mobility throughout the area
- Capital mobility and price and wage flexibility
- Member nations willing to make fiscal transfers between each other
- Similar business cycles
