International Trade Flashcards
What is on the balance of payments?
Current Account
Financial Account
Capital Account
What is on the Current Account?
Net trade in goods and services and net income flows and transfers
What is on the Financial Account?
This shows the flows of money related to investment – both into and out of a country.
• Foreign Direct Investment (FDI)
• Buying shares, bonds, etc.
• Currency reserves held by a central bank (like foreign currencies or gold).
• “Hot Money” Flows
Advantages and Disadvantages Of A Fixed Exchange Rate?
Advantages:
• Stability & certainty: Good for trade and investment – businesses know what exchange rate to expect.
• Low inflation: Helps control inflation, as the country needs to keep its currency strong.
• Reduces speculation: Less incentive to speculate if exchange rates are stable.
Disadvantages:
• Loss of monetary policy control: Interest rates may have to be used to maintain the peg instead of controlling inflation or growth.
• Risk of currency crisis: If the fixed rate is unrealistic, speculation can force a devaluation (e.g. UK in 1992).
• No automatic correction: Trade imbalances (like deficits) don’t self-correct.
Advantages and Disadvantages of a Floating Exchange Rate
Advantages:
• Monetary policy freedom: Central bank can set interest rates for domestic goals like inflation and growth.
• Automatic stabiliser: Trade imbalances adjust over time – e.g. a deficit weakens the currency, making exports cheaper.
• No need for large reserves: Government doesn’t need to hold foreign currency to intervene.
Disadvantages:
• Exchange rate volatility: Can deter investment and trade due to uncertainty.
• Imported inflation: A falling currency can make imports more expensive.
• Speculation: Floating currencies can be heavily influenced by market sentiment, not fundamentals.
Advantages and Disadvantages Of A Managed Floating Exchange Rate
Definition: Currency mostly floats, but the central bank occasionally intervenes to smooth out large fluctuations or hit a target.
Advantages:
• Combines benefits of both: Some stability from intervention, but flexibility from floating.
• Prevents excessive volatility: Can reduce harmful short-term swings in exchange rate.
• Policy flexibility: Can still use monetary policy for domestic objectives.
Disadvantages:
• Uncertainty for markets: Hard to predict when the government will intervene.
• Still vulnerable to speculation: Especially if intervention lacks credibility.
• Cost of intervention: Using reserves or adjusting interest rates can have economic side effects.
Advantages and Disadvantages Of A Current Account Deficit
Advantages:
• Higher consumption and investment: Imports may include capital goods that boost productivity.
• Living standards may rise: Consumers have access to more goods and services from abroad.
• Signals strong domestic demand: Can reflect a growing economy attracting imports.
Disadvantages:
• Unsustainable in the long run: Persistent deficits may require foreign borrowing or asset sales, leading to rising debt.
• Currency depreciation: Increased demand for foreign currency to pay for imports can weaken the domestic currency.
• Loss of confidence: Investors may view it as a sign of structural weakness
Advantages and Disadvantages Of A Current Account Surplus
Advantages:
• Stronger currency: Demand for exports boosts currency value, helping keep inflation low.
• Foreign investment income: A surplus may reflect a strong investment position overseas.
• Economic stability: A surplus can indicate a competitive and productive economy.
Disadvantages:
• Reduced consumption and living standards: Can suggest weak domestic demand or underconsumption.
• Currency appreciation: Makes exports more expensive, which can hurt future trade competitiveness.
• May cause global imbalances: E.g. if one country saves excessively, others must run deficits to balance global trade.
Expenditure Switching Policies
Aim: Shift demand from imports to domestically-produced goods.
• Devaluation/Depreciation of the currency (if floating): Makes imports more expensive and exports cheaper.
• Tariffs and Quotas (Protectionism): Reduces imports by increasing their cost or limiting their quantity.
• Subsidies for domestic industries: Make local goods more competitive.
Evaluation:
• Devaluation only works if demand for exports and imports is price elastic (Marshall-Lerner Condition).
• Protectionism may cause retaliation, reducing exports.
• Subsidies can be expensive and distort competition.
Expenditure Reducing Policies:
Aim: Cut overall demand, especially for imports.
• Tight Fiscal Policy: Raise taxes or cut government spending to reduce disposable income and demand for imports.
• Tight Monetary Policy: Raise interest rates to reduce consumer spending and borrowing.
Evaluation:
• Reduces both imports and domestic demand – can lead to lower growth or recession.
• Politically unpopular.
• May be more effective if the marginal propensity to import is high.
Supply Side Policies (Reducing BOP deficit):
Aim: Improve productivity and competitiveness in the long run.
• Invest in education, training, and infrastructure.
• Promote innovation and reduce business regulations.
• Support industries with export potential.
Evaluation:
• Effective for long-term competitiveness and export growth.
• Takes time to have an effect.
• Requires consistent policy and investment.
Examples
UK - Deficit
US - Deficit
EU - Surplus
China - Surplus
Vietnam - Surplus
UK Trade Elasticities
Export - 0.4
Import - 0.3
MARSHALL LERNER CONDITION NOT MET SO DEPRECIATION HAS LIMITED IMPACT OF IMPROVEMENT
Vietnam Trade Elasticises
Export - 1.2
Import - 0.6
MARSHAL LERNER CONDITION MET SO DEPRECIATION WOULD IMPROVE DEFICIT
How to calculate terms of trade?
(Index Change In Export Prices)/(Index Change In Import Prices)
