lesson 5: the balance of payments Flashcards
what are the three accounts that makes up the balance of payments?
the financial account
the current account
the capital account
why is the financial account significant?
flow of investment into and out of the UK including FDI
why is the current account significant?
inflow and outflow of trade of goods and services, income including from FDI and transfers between the UK and other countries
why is the capital account significant?
small section that covers debt forgiveness and buying/selling non physical assets like copyrights
What is the balance of payments?
The record of all financial and transactions between one country and the rest of the globe
what has FDI increased?
jobs
skill level
aggregate demand
LRAS
what are the four parts of the current account?
trade in goods
trade in services
investment incomes
current transfers
what are the effects of FDI?
the initial flow of investment will in the long run see the money flow out of the country in the form of investment income which will appear in the current account
MNCs may increase employment
MNCs can help spread knowledge and understanding
MNCs output counts toward the home country’s GDP
tax revenues rise
pollution rising if MNCs locate where there is slack environmental laws
what will happen to the current account if we increase our imports?
decrease due to the leakages in the circular flow of incomes leaving
what are the reasons why the UK has a deficit on the current account of the BOP?
1) strong currency —> decrease in price of imports + increase price of exports —> imported inflation
2) lack of demand abroad —> global slow down
3) low productivity —> supply side policies
what are the reasons why FDI is a good thing for an economy?
1) increased economic growth —> jobs
2) increased access to global markets
3) infrastructure development
what are the ways the UK might reduce the deficit on the current account?
1) invest in education
2) weaken the currency —> decrease interest rates + sell the currency
causes consequences and solutions to a current account deficit
1) strong currency (decreases price of imports and increases price of exports) - leads to higher interest rates to attract foreign capital - invest in domestic industries (reduce dependency on imported goods) weaken the currency (decrease interest rates and sell it) however this leads to the battle of the uglies (everyone wants to weaken the currency but it leads to imported inflation)
2) high domestic demand for imports (lack of demand abroad and lots of consumer spending) - reduced econ growth if the trade deficit worsens - fiscal policies to reduce excessive domestic demand (expansionary policies and expenditure switching)
3) supply side constraints (low productivity is why we import a lot) - loss of investor confidence in the economy so we struggle to compete with NIEs (creates international structural unemployment) - invest in policies to reduce reliance on imports (invest in education to drive up skills and productivity. policies take time and are expensive)
what is the battle of the uglies?
everyone trying to weaken their currencies to make their exports cheaper but lowering interest rates and selling the currency
but everyone weakening their currency will lead to imported inflation
what will investment income received by the UK companies by foreign investors appear as on the UK current account?
When investment income is received by UK companies by foreign investors, it will appear as a positive number on the UK Current Account, which will increase
what will investment income paid by the UK companies to foreign investors appear as on the UK current account?
When investment income is paid by UK companies to foreign investors, it will appear as a negative number on the UK Current Account, which will decrease
what is a portfolio investment?
purchase of financial assets like bonds or shares rather than productive assets like factories
formula for trade balance
(value of exported goods + services) - (value of imported goods + services)
what is an example of a short run capital flow?
in a speculative manor
if investors expect the value of the pound to rise in the near future
they will buy it
hot money flows into the uk
but hot money can be destabilising since money may be pulled out quickly if interest rates drop or expectations change
what is the issue with hot money
hot money can be destabilising since money may be pulled out quickly if interest rates drop or expectations change
what is the balance of trade? what is important to remember about it?
the difference between the total value of exports and imports
important: THIS IS VISIBLE TRADE
what else is the balance of trade in goods referred to as?
visible trade
what else is the balance of trade in services referred to as?
invisible trade
what are transfers?
payments flowing between countries in forms such as foreign aid, grants and payments to the EU
what is net income flows?
shows income earned by uk firms minus income earned in the uk by overseas firms
reasons why the UKs current account may be in a deficit?
strong currency
inflation
productivity
quality
falling incomes abroad
rising incomes at home
what are policies used to cure a current account deficit?
the three Ds
deflation
direct controls
devaluation
how can deflation be used to cure a current account deficit?
contractionary policy to reduce AD
reduces demand for import
but carries the risk of unemployment and likely to have a small impact
how can direct controls be used to cure a current account deficit?
import controls like tariffs and quotas
tends to provokes retaliation
doesn’t cure the underlying problem of lack of competitiveness
how can devaluation be used to cure a current account deficit?
weaken the exchange rates to change the relative price of domestic and foreign goods but effectiveness depends on elasticities
what does the impact of fall in the external value of a currency depend on?
price elasticities of exports and imports
does weakening the currency work?
in the short run the BOP may deteriorate
but in the long run the BOP may improve but this depends on elasticities
however this may not last as any price competitiveness produced by the devaluation in likely to be eroded by increased import prices driving up inflation
shown by the J curve
when do we have a current account surplus?
when money is coming into the economy
what are two negatives of a current account deficit?
may upset your trading partners
one countries surplus is the cause of another’s deficit
what are the three policies to fix a current account surplus?
reflation - expansionary policies to increase AD thereby increasing demand for imports
removing import controls - liberalise trade, remove barriers
revaluating - strengthen the exchange rate to change the relative price of domestic an foreign goods
what are gilts?
british government bonds
what are positives and negatives of FDI?
p: jobs, boost LRAS and AD, increase skill levels
n: flows out in the long run
what is a run on the pound?
when investors lose confidence in the british currency leading to a decline in its value
define a current account deficit
When total outflows from the current account are greater than total inflows.
reverse outflows for inflows for surplus
