The Balance of Payments

Question 1

The BOP records All Financial Transactions of a country with other countries

Answer 1

1. The balance of payments records all flows of money into and out of a country.
2. The UK BOP is made up of the current account, the capital account and the financial account.

Question 2

There are four sections of the Current Account

Answer 2

1. Trade in goods:
   a) Trade in goods measures imports and exports of visible goods - e.g. televisions, apples, potatoes, books.
   b) UK’s biggest goods exports include things such as machinery, mechanical appliances and pharmaceuticals
   c) The UK’s biggest goods imports also include machinery and mechanical appliances, along with mineral fuels and oils.
2. Trade in services
   a) Trade in services measures imports and exports of services such as insurance or tourism.
   b) some of the UK’s biggest exported services are banking and insurance.
   c) The UK’s biggest imported services include tourism e.g. holidays abroad
3. Investment and employment income
   This covers flows of money in and out of a country resulting from employment or earlier investment - e.g:
   - Deposits in foreign banks recieve interest payments.
   - Businesses set up overseas by a UK company will earn profits for the UK parent company
   - Shares bought in foreign firms will being dividend payments to the UK shareholder - the share themselves wont appear on the current account
   - Salaries paid to UK redients working abroad
4. Transfers
   a) Transfers are the movements of money between countries which aren’t paying for goods or services and aren’t the result of investment.
   b) Transfers include payments made to family members abroad and aid paid to or recieved from foreign countries

Question 3

Add up the individual balances to find the overall Current Account Balance

Answer 3

Recent Data on the UK’s balance of payments shows:

• Large deficit on the balance of visible trade - the UK imports more goods than it exports
• Small surplus on the balance of invisible trade - the UK exports slightly more services than it imports
• Surplus on flows of investment income = the UK recieves more payments from investment than it pays out.
• A deficit on transfers e.g. UK makes foreign aid payments, amongst other things.

As a result, the UK has a large deficit on its current account, and it has had a deficit every year since 1984. This means that the UK’s current macroeconomic policy includes having to deal with a balance of payments deficit.

Question 4

There are usually Many Causes of a BOP Surplus or Deficit

Answer 4

A country might experience a current account deficit if:

1. There are high levels of consumer spending
   - When there’s economic growth, consumers and firms but more imports
   - If the income elasticity of demand for imports is high then there will be a greater increase in imports.
2. It’s struggling to compete internationally
   - Countries that can’t compete internationally will see a reduction in exports
   - Some countries may not be able to compete with los costs of production in other countries, e.g. newly industrialised nations.

# when the costs of production in a country rise faster than in competitor countries e.g. due to higher labour costs, production inefficiencies, a fall in labour productivity etc, then exports will fall and imports will rise. 
#Other countries may struggle to compete with countries that have access to more advanced technology or more efficient methods of production, which can lower costs and improve the quality of the products they make. 
#If the country has structural problems, e.g. labour immobility, this could be making domestic products and exports more expensive. 

• A rise in the value of a currency will make goods more expensive to foreign buyers, so exports will fall. At the same time, foreign goods will be cheaper to buy, so imports will rise.
• If inflation rises exports will fall because they’ll become more expensive and less competitive in foreign countries. Imports will rise because it’ll become cheaper for consumers and firms to buy imports rather than domestic products.

3. It had to deal with external shocks
   - If there’s a rise in the world prices of imported raw materials e.g. oil, timber or metals, and the demand for these materials is relatively price inelastic, then a country will end up paying more for these imports - at least in the short run.
   - An economic downturn in countries to which a country exports can cause a sudden reduction in the amount of exports that are demanded.
   - The imposition of trade barriers on goods by a trading partner could mean a sudden reduction in the number of exports made to that country.

Question 5

A country might experience a current account surplus if…

Answer 5

1. Its been experiencing a recession - sometimes domestic producers will struggle to sell products domestically, so they’ll focus their efforts on competing in international markets instead. There may be a fall in imports too as a result of an overall reduction in spending.
2. Its domestic currency has a low value - this will make exports cheaper and imports more expensive.
3. High interest rates are causing more saving and less spending.

Question 6

There can be consequences of a BOP surplus or Deficit:

- Consequences of a BOP deficit

Answer 6

1. A balance of payments deficit could indicate that an economy is uncompetitive.
2. A deficit isn’t always a bad thing - it might mean that ppl in that country are wealthy enough to be able to afford lots of imports. A deficit may also allow ppl to enjoy a higher standard of living, as they’re importing the things they want and need. But, a long-term deficit is likely to cause problems
3. The consequences of a deficit include a falll in the value of the currency => to higher import prices - at least in the short run. This can => increase in inflation.
4. A B of P deficit might also => job losses domestically, e.g. if more goods are being imported, that may mean fewer goods need to be produced domestically, so unemployment may increase.

Question 7

There can be Consequences of a BOP surplus or deficit: Consequences of a BOP Surplus

Answer 7

1. Surpluses can show that an economy is competitive
2. However, if a country has a surplus for a prolonged period of time, e.g. Japan, they may experience stagnation. This means that, for example, due to low domestic demand, they’ll experience low, or even negative, economic growth - which also had the potential to => other problems such as high employment.
3. A large surplus on a current account may also be a result of an economy’s overreliance on exports.
4. If a surplus is created by a country having an undervalued currency, this will create inflationary pressures - the price of imported components for use in production will rise, meaning a rise in the costs of production and therefore a rise in the price level.

Question 8

Governments often try to Correct Imbalances in the BOP

Answer 8

1. Governments might try to correct a BOP deficit:
   - They might use policies to reduce the price of domestic goods - this should increase exports and reduce imports. e.g. a government might use supply-side policies to remove structural problems.
   - governments might impose restrictions on imports - e.g. a government might impose tarriffs on imports to make them relatively more expensive for domestic consumers. This might => inflation if demand for imports is too price inelastic.
   - May devalue (fixed exchange rate systems) or depreciate (floating exchange rate systems) the currency-> this will make exports cheaper and imports more expensive. For this to be successful, the Marshall-Lerner condition must hold.
   - Governments might use fiscal or monetary policy to reduce spending in the economy - however, as well as reducing imports, its likely to also reduce domestic demand and harm economic growth.
2. Governments might use fiscal or monetary policy to reduce spending in the economy - however, as well as reducing imports, its likely to also reduce domestic demand and harm economic growth.
3. When the governments of major economies try to correct imbalances in their BOP, it can have global impacts:
   - supply-side policies to correct deficits may => increase world trade and growth
   - restrictions on imports can => trade wars, reducing international trade and => to lower global efficiency. Restrictions might also break WTO rules.
   - If a governments attempts to reduce its BOP deficit => a fall in exports from developing countries, this may have many negative consequences. E.g. economic growth in those developing countries will be limited, => a rise in unemployment. Reduced economic growth in developing countries has the potential to hold back global improvements in efficiency.

Question 9

The Capital and Financial accounts show Asset Transfers

Answer 9

1. The capital account includes transfers of non-monetary and fixed assets - the most important part of this = the flow of non-monetary and fixed assets of immigrants and emigrants, e.g. when an immigrant comes to the UK, their assets become part of the UK’s total assets.
2. the financial account involves the movement of financial assets. It includes:
   - Foreign direct investment (FDI)
   - Portfolio investment - investment in financial assets, such as shares in overseas companies.
   - Financial derivatives - these are contracts whose value is based on the value of an asset, e.g. a foreign currency.
   - Reserve assets - these are financial assets held by the B of E to be used as and when they’re needed.
3. Income from the financial account, e.g. in the form of interest, is recorded in the current account.
4. The current account should balance the capital and financial accounts, e.g. a deficit of £5 bn on the current account should be offset by a surplus of £5bn on the capital and financial accounts. However, due to errors and omissions, the current account and capital and financial accounts often don’t balance, so a balancing figure is needed.

Question 10

These are both Short-term and Long-term capital and financial flows

Answer 10

1. Long-term flows are due to things such as FDI and portfolio investment. They’re usually quite predictable as, for example, FDI is often made when a country gains a comparative advantage in producing something, which tends to happen over a long period of time.
2. Short term flows (sometimes called ‘hot money’) are based on speculation and people/ firms trying to quickly make money - e.g. by moving money from one currency to another expecting to make a profit through changes in exchange rates.

Question 11

International economies are more interconnected than ever before

Answer 11

1. International trade and capital flows mean that any firms and governments have interests and investments in lots of different countries.
2. This allows those firms and economies to grow in ways that wouldn’t be possible otherwise.
3. However, it also means that economies are now dependent on each other much more than every before. e.g. the banking crisis in one country can now cause economic problems in many different countries -e.g. if foreign firms or governments have borrowed or lent money to banks that have collapsed.
4. Similarly, if one country enters a recession, then this might cause problems for countries that trade with it.
5. These connections mean that global trade imbalances carry a serious risk. e.g. the USA currently had a very large current account deficit, while China has a very large surplus. If the USA imposed tariffs to try and reduce their deficit, then other countries could retaliate with their own tariffs, harming trade and damaging economies.