Macroeconomics: Balance of payments Flashcards
What is the balance of payments?
Records all financial transactions made between consumers, businesses, and the government in one country with other nations.
What are the 3 main parts of the balance of payments?
Current account
Financial account
Capital account
What is the current account?
Records payments for trade in goods and services plus net flows of primary and secondary income.
The sum of these 4 separate balances:
net balance of trade in goods and services
net primary income
net secondary income
What is primary income?
The income received or paid for the use of factors of production such as labour and capital. It is part of the current account and reflects cross-border flows of income derived from investments or employment.
Which income flows appear in the primary income?
Income on direct investment - profits, dividends, and interest earned by residents from their direct investments in foreign companies.
Income on portfolio investment - dividends, interest earned by residents from portfolio investments in foreign securities.
Compensation of employees - wages, salaries, and other compensation earned by foreign workers employed in a country and by residents working abroad.
Taxes on income and wealth paid to foreign governments and taxes paid by foreign residents to the domestic government.
What is secondary income?
Refers to transfers of resources without any direct exchange of goods, services, or assets in return. It is recorded in the current account and includes unilateral transfers between residents and non-residents.
Which income flows appear in the secondary income?
Payments made by international institutions
Remittance for developing economies - money sent by foreign workers back to their home countries.
Foreign aid - grants, concessional loans.
What is the financial account?
Includes transactions that result in a change of ownership of financial assets and liabilities between a country’s residents and non-residents.
This includes:
Net balance of FDI
Net balance of portfolio investment flows (inflows/outflows of debt and equity)
Balance of banking flows (hot money flowing in/out of a country’s commercial banks)
Changes to the value of a country’s reserves of gold and foreign currency.
What is a current account deficit?
The value of a country’s exports of goods and services, investment incomes, and transfer inflows are lower than spending on imported goods and services.
What are the causes of a current account deficit?
Cyclical causes - when an economy is experiencing a boom, rising real incomes and consumer spending, and falling savings ratios can lead to a surge in import demand which can cause an increase in the size of the trade deficit.
Structural causes- focus on supply-side weaknesses in an economy such as relatively low capital investment, low productivity and research and businesses not operating at the cutting edge of innovation.
What are the short run causes of a current account deficit?
A fall in the value of exports is perhaps caused by a decline in the world price of a nation’s major exports (especially for primary producers).
A boom in consumer spending increases the demand for imports.
Strengthening exchange rates might make a country’s export sector less price-competitive in overseas markets.
What are the long run causes of a current account deficit?
Low rates of capital investment limit the overall productive capacity and cost competitiveness of key export industries.
Relatively high cost and price inflation contrasted with trade partners.
Weaknesses in non-price competition such as branding and innovation.
Long-term decline in previously dominant export sectors such as deindustrialisation in manufacturing, the decline in extractive sectors.
What are the macro effects of a current account deficit?
Fall in AD since (X-M) is negative - leading to slower GDP growth.
Drag on GDP growth might then lead to weaker investment and jobs (exports are less price competitive).
A larger external deficit is likely to lead to a depreciating exchange rate.
A high external deficit may reflect weaknesses on the supply-side.
However, may reduce inflationary pressures if exports are more expensive.
May not be as harmful if the deficit is restricted to certain sections in the current account.
What are examples of expenditure-switching policies?
Depreciation of the exchange rate - reduces the relative price of exports and makes imports more expensive - the risk of cost-push inflation, which erodes competitive boast and fall in real incomes/standards of living.
Import tariffs - increase the price of imports and make domestic output more price competitive - risk of retaliation from other countries if import tariffs are used as a BoP policy.
Low rate of inflation (perhaps deflation) - keeps general price level under control and makes exports more competitive - risks from deflation as a way of achieving internal devaluation, including lower investment.
What are expenditure-switching policies?
Expenditure-switching policies are economic strategies aimed at altering the allocation of a country’s spending between domestic and foreign goods and services. These policies are typically used to address imbalances in the current account, such as a trade deficit, by encouraging consumers and businesses to reduce imports and increase consumption of domestically produced goods.
