Macro 8 - The current account of the balance of payments and exchange rates Flashcards
What is the balance of payments?
The balance of payments is a record of payments between one country and the rest of the world. It is made up of the current account, the capital account and the financial account
What is the balance of payments made up of?
- The current account
- The capital account
- The financial account
What is the current account?
The current account is the part of the balance of payments which records trade in goods, services, investment income and current transfers
What are the four sections of the current account?
- Trade in goods
- Trade in services
- Investment income (primary income)
- Current transfers (secondary income)
What are the four sections of the current account?
- Trade in goods
- Trade in services
- Investment income (primary income)
- Current transfers (secondary income)
What does the trade in goods part of the current account consist of?
Trade in goods measures the movement of tangible products across international borders
What does the trade in services part of the current account consist of?
Trade in services measures the movement of intangible output between countries
What does the investment/primary income part of the current account consist of?
Investment/primary income covers flows of money in and out of a country resulting from employment or earlier investment. It comprises interest, profits and dividends
What does the current transfers/secondary income part of the current account consist of?
Current transfers/secondary income measures the payment of money across international borders that has no corresponding output
How do you calculate the current account balance?
Add up the individual balances of the four different components of the current account to find the overall current account balance.
A positive balance is a current account surplus and a negative balance is a current account deficit
When does a current account surplus occur?
When the value of inflows on the current account are greater than the value of outflows
When does a current account deficit occur?
When the value of outflows on the current account are greater than the value of inflows
For how long has the UK had a current account deficit?
The UK has had a deficit on its current account every year since 1984
Define the term ‘exchange rate’
Exchange rates refer to the price of one currency in terms of another currency
How can the exchange rate for pounds be thought of as for another country?
It can be thought of as how much of another currency can be bought with a certain amount of pounds
Define the term ‘hot money’
Hot money flows refer to capital flows moving to countries with higher interest rates
How do interest rates affect exchange rates?
1- As interest rates fall, saving in British banks becomes less attractive
2- This means people currently saving in British banks in the UK withdraw their savings
3- They switch their pounds into another currency for a country with higher interest rates
4- They then put these dollars (for example) into American banks. This money in known as flows of hot money
5- The process of lots of people swapping their pounds for dollars has caused less demand for the pound and so it has depreciated
6- This makes UK exports appear cheaper as the currency is now cheaper
7- This increases exports and decreases imports helping the net exports on the current account on the balance of payments
What are the causes of a current account deficit?
1- Rising income domestically (in the UK)
2- Falling income levels abroad
3- A strong pound
4- Protectionism in other countries
5- Structural problems such as poor quality goods
What is free trade?
Free trade is international trade without restrictions such as tariffs or quotas. Free trade provides benefits from specialisation, increases competition and the ability to transfer resources
When does free international trade occur?
Free international trade occurs when there are no restrictions imposed on the movement of goods and services in and out of countries
What is protectionism?
Protectionism restricts free trade, it is the protection of domestic industries from foreign competition
Why may the government use protectionist policies?
1- To protect jobs
2- To protect infant industries (industries that are just starting out)
3- To ban certain goods
4- To avoid overdependence
5- To protect against dumping (when companies sell goods abroad at a price below the cost of production to try and force other countries’ domestic firms out of business)
6- To correct imbalances in the balance of payments
What are some of the disadvantages of protectionist policies?
- Retaliation from other trading partners can make exports less competitive
- It allows uncompetitive industries to continue - perhaps it would be better long term to let that industry collapse and allocate resources in a more efficient way
What are the different protectionist policies?
1- Tariffs
2- Embargos
3- Government purchasing policies
4- Red tape
5- Quotas
What are tariffs?
Tariffs are a tax on imports which makes them more expensive and less competitive. The country’s domestic goods now seem more attractive allowing domestic industry to grow
What is an embargo?
An embargo is an outright ban on export or import of a particular product or trade with a particular country
What are government purchasing policies?
Government purchasing policies are when the government may give preferential treatment to domestic suppliers
What is red tape?
Red tape is when a country makes it difficult to import by making things take a long time in customs or by providing a lot of paperwork to be completed so firms are more likely to buy domestically
What is a quota?
A quota is a limit on the amount of a good which can be imported. It can also apply to a limit on the amount exported. A restriction of this nature typically restricts the import of a product which pushes up its price therefore causing people to turn to domestic goods instead.
