KQ: How is the Balance of Payments calculated? Flashcards
What 3 accounts comprise the Balance of Payments?
Current Account + Capital Account + Fiscal Account + net error and omissions (balancing item)
Explain what is the Current Account
The current account comprises the balance of trade in goods and services plus primary income (income earned by UK residents from non-residents and vice versa) and secondary income (represents the provision (or receipt) of an economic value by one party without directly receiving (or providing) a counterpart item of economic value).
Explain what is the Capital Account.
The capital account comprises both capital transfers and the acquisition and disposal of non-produced, non-financial assets (e.g. land, buildings, plant equipment, and patents).
Explain what is the Financial Account
The financial account comprises transactions associated with changes of ownership of the UK’s foreign financial assets and liabilities (e.g. stocks, bonds, government securities, as well as direct investment)
What are some examples of primary income?
- Interest paid on savings account in an overseas bank
- Profits paid on a UK business with an overseas operation
- Dividends paid on shares of overseas companies
- Remittances from migrant workers living and working overseas
What are some examples of secondary income?
- UK contributions to EU budget
- Military aid and military expenses
- Overseas missions and overseas aid
What is the short run impact of a current account deficit?
- Exchange rate depreciation
- Imported inflation
- Leakage/fall in real GDP
What is the long term impact of a current account deficit?
- Long term income falls
- Employment falls
- Reduced competitiveness
- Erosion of foreign exchange reserve position
What are potential causes of a current account deficit?
- Overvalued exchange rate
- High consumer spending on imports
- Unbalanced economy (relocation of manufacturing industries)
- Low savings rate
- Loss of competitiveness / Low productivity
- High domestic inflation rates
- Protectionism
What are some advantages of protectionism with respect to current account deficits?
- Makes imports less price competitive
- Source of government revenue
- Protects strategic industries (e.g. defense, agriculture)
- Protects vulnerable industries (e.g. steel)
- Allows emerging industries to develop (e.g. South Korea)
- Prevents dumping
What are some advantages of protectionism with respect to current account deficits?
- Consumer welfare/ consumer surplus decreased
- Possible retaliatory tariffs
- Possible contravention of WTO/EU regulations
- Possible government failure in determining which products to protect and degree of protection
- Lack of competition, innovation and enterprise could lead to inefficiency in the long run
What are 3 key government approaches to correct a sustained current account deficit?
1- Exchange rate intervention
2- Demand management / Expenditure reduction
3- Supply-side policies
What are key advantages of exchange rate interventions for correcting a current account deficit?
Exchange rate depreciation or devaluation
