Steedsy Theme 4 Flashcards
What is the definition of the balance of payments
Shows the record of all outflows and inflows of money
What are the UK’s main exporting goods
Cars
Power generators
Pharmaceutical products
Crude oil
What does the financial account include
Net balance of FDI inflows
Hot money
Changes to value of gold and foreign currency
Structural reasons for surpluses and deficits of the current account
Uneven distribution of natural resources
Differential in competitiveness
Investment and long term economic growth
Domestic and government spending
Cyclical reasons for surpluses and deficits of the current account
Exchange rates
Inflation
Negatives of a current account deficit
- Net outflow of AD from circular flow
- Loss of jobs in export sectors and industries affected by rising imports
- Fall in foreign exchange revenues as price of pound decreases due to less supply of money in uk economy as your money is now in another economy due to the import increase
- debt burden - people will stop buying bonds due to uncertainty over whether they will be paid back or not
- reduced quality of life due to lack of economic growth and exchange rate weakness
Causes of importing too much (deficit)
Elasticity of demand for imports (high mpm)
Decline of manufacturing
Growth of emerging markets
Lack of competitive pricing
Does a balance of payments deficit matter
- Partial auto-correction - higher demand for imports causing inflation leading to more exports
- investment and supply side
- the financial account is positive
why does it matter if there is a balance of payments deficit
loss of output and employment
money flowing out and problems financing the debt
what are expenditure switching policies
Expenditure-switching policies aim to switch consumer spending towards domestic goods, and away from imports. Reducing the growth of the supply of money in an economy can be expenditure- reducing or expenditure-switching.
examples of expenditure switching policies
exchange rate policies (to deprecate pound)
protectionism
how do exhcange rates policies impact the deficit and what are the methods of changing exchange rates
they use methods which depreciate the value of the pound to make exports cheaper. this is done by:
lowering interest rates (SPICED)
increasing the supply of pounds which is done by increasing the demand for foreign currency which increases the supply of pounds for UK, lowering the price
evaluate the exchange rate methods to depreciate the pound
evaluating:
- lower interest rates - time lag; lowering interest rates can cause inflation leading to lower demand for domestic goods; magnitude of interest rate change; liquidity trap
- increasing the supply of pounds - only so much foreign currency to buy so can take a while
methods of protectionism
embargo (ban)
tarrifs
red tape
tax
quota (physical limit)
import duty
evaluate protectionism
retaliation
difficult to administer
what is the difference between expenditure switching and expenditure reducing policies
Expenditure-reducing policies aim to reduce demand in the economy, so spending on imports fall. Expenditure-switching policies aim to switch consumer spending towards domestic goods, and away from imports. Reducing the growth of the supply of money in an economy can be expenditure- reducing or expenditure-switching.
What would you use to increase international competitiveness and state examples of this policiy
Only use supply side policies as they improve quality, lower prices and attract FDI
Subsidies
Gov spending on education (more productive) and infrastructure
Lower corporation tax
Less spending on unemployment benefits
Deregulation
Lower/ freeze min wage
What is the marshall lerner condition
The marshall lerner condition is satisfied of the absolute sum of a countries export and import elasticities is greater than 1 (elastic)
Examples of deficit removal policies (of exports and imports)
Exchange rate policies (WPIDEC)
Protectionism (increasing prices of imports to encourage demand for exports)
Government investment in domestic industries (subsides increase supply so decrease prices of exports)
Deflationary policy (lower prices make exports more competitive)
Supply side policies (such as subsidies)
how does tight fiscal affect the balance of payments
less disposable income to be able to be spent on imports
Possibly lowering the price of exports which would improve it further
evaluate using tight fiscal policy to improve the balance of payments
magnitude of the price drop
confidence
price is not the only determinant of exports e.g quality
marshall-lerner condition
Conflict of objectives
evaluate using tight monetary policy to affect the balance of payments
imports may increase due to spiced
time lag
liquidity trap
narshall lerner condition
methods of supply side policy used to reduce a trade deficit
lower corperation tax
removing red tape so more productive
privatisation
investment in healthcare and education
reduce welfare payments
how will government investment in domestic industry improve the trade deficit
to make exports cheaper
to replace imports
examples of expenditure reducing policies
contractionary monetary and fiscal
the priority is reducing imports
if there is significant disinflation, may lead to an increase in exports as more competitive
evaluate using expenditure reducing policies to reduce the trade deficit
could cause a recession or deflation
conflict of objectives
depends on elasticity of demand for imports
does it matter if there is a current account deficit
depends on what the percentage deificit is compared to real gdp
if the percentage of deificit of gdp is greater than percentage growth then it isn’t sustainable so would be a priority
what should you talk about if there is a question on improivng international competitiveness
if there is a question on improving international competitiveness only talk about supply-side policy as this lowers the price of uk goods
why do some countires have a trade surplus
export orientated growth
FDI
under valued exchange rate
high domestic savings - banks have more money to lend
what are the demand side causes of a trade surplus
weak excange rate
high incomes abroad
low inomes domestically
supply side causes of a trade surplus
low relative inflation
lower labour costs (high productivity, low min wage)
strong investment
new resource discoveries
consequences of a trade surplus
financial account deficit
appreciation of exchange rate
higher (x-m)) means higher AD so inflation
what is a shut down point
A shutdown point is a level of operations at which a company experiences no benefit for continuing operations and therefore decides to shut down temporarily—or in some cases permanently. It results from the combination of output and price where the company earns just enough revenue to cover its total variable costs.
what are the different types of exchange rates
spot exchange rate - the rate for a currency at todays market prices
forward exchange rate - a forward ate involves the delivery of a currency at a specified time in the future at an agreed rate
bi-lateral exhcange rate - the rate at which one currency can be traded against another
When demand for another currency increases, what happens to the supply of pounds
When demand for another currency increases, the supply of the pound will increase
What are the factors affecting exchange rates
Trade balances
Foreign direct investment
Portfolio investment
Interest rate differentials
What is competitive depreciation
Buying and selling currency
Advantages of using a floating exchange rate
Stability in the balance of payments
Market efficiency enhances
Foreign exchange is unrstricted - currences can be traded without restrictions
Useful instrument for economic adjustment
Imoirt inflation protected - if it was fixed, countries face the problem of importing inflation through surpluses of the balance of payments or higher prices of imports
Fixed exchange rate advantages
• Trade and investment - less currency risk, overseas investors will be more confident to get a return on their investments as the pound wont fluctuate
• some flexibility permitted
• reductions in the costs of currency hedging- businesses have to spend less on currency hedging inf currency is stable
what is hedging
securing the price now for future exchanges (to get rid of any uncertainty)
drawbacks of a fixed exchange rate
• risk of over-valued exhcange rate leading to deflation and a reduction in economic growth
• can lead to permanent imbalance in current account
• reduced freedom to use interest rates
what is managed floating
this is wen the central bank may choose to intervene in the foreign exchang markets to alter the exchange rate
reasons for managed floating
• improve the balance of trade
• reduce the risk of deflationary recession - becuase exports demand increases the domestic price level by making imports more expensive
• to rebalance the economy
• appreciation of currency
• or to reduce prices of imported capital and tech
methods to cause a depreciation of the pound
QE so the money supply increases
reduce interest rates to cause hot money outflows
sell home currency and buy foreign currency to depreciate the pound (as demand for pound decreases)
methods to appreciate the value of the pound
reduce taxes on income from assets to attract overseas investors to buy the currency
raise interest rates
buy home currency, sell foreign currency
what are the limits to central bank intervention to mnage a currencies value
requires large scale foreign exchange reserves
changing interest rates conflicts with othher macro objectives
j curve
marshall - lerner condition
what are the factors affecting international competitiveness
exchange rates
productivity
quality
wage and non-wage costs
research and development
taxation - lower corporation tax to encourage investment
what are the benefits of being internationally competitive
current account surplus
employment and economic growth
wage growth
higher domestic purchasing power
international investment
problems of sustaining competitiveness
trade barriers
current account surplus leads to appreciating exchange rate
other rising domestic costs
policies that woud be used to increase international competitiveness
supply side policies
tight monetary (to lower inflation) or lowering interest rates (for exchange rates)
tight fiscal - to lower inflation
what are the top 4 Uk expenditures on
1 - social protection £341bn
2 - health £245bn
3 - education - £131bn
4 - DEBT INTEREST - £116bn
what 3 things does government spending have an impact on
• productivity - investment on education and healthcare makes workers more efficient; subsidies means better equipment and tech; transport, less time wasted.
• growth and employment - subsidies mean higher supply so lower prices leading to an increase in consumption
• living standads and equality- better healthcare, welfare payments
Explain crowding out
Increased government spending
If there is large government spending it will have to sell debt to the private sector.
To encourage consumers to buy the bonds they may require higher interest rates. Therefore less private investment and consumption
Eventually government spending needs to be funded by higher taxes to squeeze in spending further.
Evaluate crowding out
Supply of loanable funds is not limited to domestic sources
Strong multiplier value
Fiscal deficits crowd in private sector investment
Why is the uk debt sustainable
Bank of England owns majority of bonds
Interest rates are very low so servicing it is easier for the government
Finance available abroad (foreign investors buy government bonds)
To what extent is a rise in national debt a concern
Higher taxes so lower economic growth in the long run
Crowding out
Higher chance of government defaulting on payments so could decrease confidence
What are automatic stabilisers
Government spending and taxes change as the economy moves through stages of the trade cycle. E.g less tax revenue during a recession. E.g during a boom there will be less spending on unemployment benefits
What is discretionary fiscal policy
Deliberate manipulation of variables to influence the economy.
What is cyclical fiscal balance
The size of the fiscal deficit is influenced by the state of the economy. In a boom, tax receipts are high and spending on unemployment benefits is low
What is structural fiscal balance
The part that is related to the economy (boom or recession)
Causes of fiscal deficits
Increase in interest rates on debt
Increase in inactivity leading to a rise in welfare benefit spending
Recession causing rising unemployment
Decrease in consumer spending
Demographic factors such as an ageing population
what is external debt
debt owed by the government, businesses and people of a country to overseas lenders such as banks
what are the three types of tax and define them
progressive tax - as income rises tax rises
proportional tax - marginal rate of tax is constant leading to a constant average rate of tax
regressive tax - tax rate paid falls as incomes rise
what is fiscal drag
when tax brackerts dont increase in line with inflation or income, causing people to pay more tax, drags into higer tax brackets
what is the likely impact of an increase in protectioonism on the global economy
• Higher prices for consumers, especially on goods/services that can’t be produced domestically, e.g. bananas in the UK, increasing inflation globally
• Higher prices for consumers due to domestic firms facing less competition from abroad
• Less choice for consumers as imports become too expensive
• Fewer firms may decide to export due to increased cost/bureaucracy to abide by, reducing global competition and therefore lower global
GDP, higher global inflation
• Reduction in comparative advantage globally leading to less productivity and less output
why may tax revenue fall if tax increases
• increase in tax reducing the incentive to work
• increase tax reducing the incentive to spend in the economy
• increased incentive to tax avoid/evade
evaluate the laffer curve
• tax cuts could lead to workers taking more leisure time and working less so less tax revenue (backwards bending labour supply curve)
• lower top rate taxes might increase income inequality
what happens to imports if tax increase
if tax increase imports decrease as prices lower in uk
how would lower tax rates affect FDI
some countries encourage FDI investment by lowering taxes such as corporation tax to incentivise firms to set up in these countries
what are the problems with sustained government debt and borrowing
• interest payments on the debt
• increase in taxes to pay off the debts
• less capital available to spend on investment into the economy (opportunity cost)
• crowding out
• potential negative impact on exchange rates - less confidence in gov paying back debt means less investment into economy so depreciation of exchange rate
• confidence is reduced
methods to reduce government debt
• spending cuts
• raise taxes
• privatisation
• expansionary policicies
• depreciation policies
evaluate whether national debt is actually a concern
depends on the cost of annual debt interest payments
depends on the ability of the government to attract investors to buy new debt
could be due to a servere external shock
it is rational to borrow to invest when market bond yields are low
advantages of using quantitative easing
extra tool of monetary policy
can lead to a depreciation of the exchange rate
can increase confidence
evalute QE
liquidity trap
can create zombie companies
inflation could lead to housing and wealth inequality which worsens geographical mobility
state the aims of supply side policies
improve inentives to work
increase productivity
encourage start ups
promote contestability and innovation
increase capital investment
criticisms of market based supply-side policies
income inequality - tax cuts that primarily benefit high income earners
underinvestment in public goods such as infrastructure
financial instability - e.g due to deregulation
what are the limits to the governments ability to control global companies
corruption - to influence politicians
tax avoidance - done via transfer pricing
power of the firm to achieve economies of scale so less revenues for frims and lower wages paid
problems facing policy makers when applying policies
innacurate information
inability to control external shocks
what is transfer pricing
Transfer pricing is a legal technique used by large businesses to move profits around from parent companies to subsidiaries and affiliates to ensure funds are evenly distributed. However, many multinational corporations use it as a tactic to lower their tax burdens
positives of a floating exchange rate
freedom of use of domestic monetary policy
useful instrument for macroeconomic adjustment
useful instrument to alter imports / exports
reduced risk of overvalution and undervaluation
evaluate using a floating exchange rate
volatility which reduces incentives for FDI into domestic economy
positives of fixed exchange rate
decreased exchange rate uncertainty so increased FDI
reduced need for hedging (buying at a certain exchange rate for a product in the future) which is an extra cost - so reduced cost of trade
evaluate using a fixe exchange rate
interest rates used to keep it at a fixed level will have effects on economy
risk of over/under valuation which damages bofpayments
evaluate raising taxes to reduce inflation
reduces quality of life/increase level of poverty
