The Balance of Payments and Exchange Rates Flashcards
Define Balance of Payments?
A record of all movements of money between an economy and the rest of the world
What is the objective of balance of payments?
Balance of payments equilibrium: The amount of money leaving an economy (outflows) should be equal to the amount of money entering an economy (inflows)
What are exports considered as?
Inflows
What are Imports considered as?
Outflows
What are some examples of Inflows and Outflows?
- Trade (exports/imports)
- aid
- Investment Income (money from investment abroad)
- Immigrant income
- Fees to/ Grants from
- FDI, Foreign Direct Investment (money to establish a business)
What are the 3 accounts that all inflows and outflows are organised into?
- Current Account
- Capital Account
- Financial Account
What inflows and outflows are included in the current account?
- Trade in goods
- Trade in services
- Investment income (includes interest on loans)
- Current transfers (includes fees to/grants from and insurance premiums)
Reasons for a trade deficit?
- Factor endowments (land, labour, capital)
- Lower prices in competitor economies
- quality of goods
- Marketing skills
What is the problem with having a balance of payments deficit?
- Concern is expressed when the economy relies on borrowing from overseas banks, this represents an increase in the UK’s external debt, upon which interest must be paid out of future export earnings.
- fall in AD as imports increase
- loss of jobs in home businesses
- loss on investor confidence
- can lead to currency weakness and higher inflation
What is the concern with having a Balance of Payments surplus?
- A surplus means that resources have been directed away from domestic spending to meet the overseas demand for exports
- can lead to inflation
Define exchange rate?
An exchange rate is the price of a currency measured in terms of some other currency.
In a supply and demand curve for a currency what does the demand curve represent and what does the supply curve represent?
- Demand curve- inflows
- Supply Curve- outflows
As the value of a currency increases what is it said to be?
Stronger
As the value of a currency decreases what is it said to be?
Weaker
What are the strengths or weaknesses of currency based on?
Inflows and Outflows
If lots of money is leaving an economy what is the currency said to be?
Weak
If lots of money is entering an economy what is the currency said to be?
Strong
What are the four determinants of shifting the demand and supply curve of currency?
1) Trade: Imports (supply), Exports (demand)
2) FDI: -Foreign Direct Investment
- Investment in the UK by foreigners (Demand)
- Investment outside UK by UK firms (Supply)
3) Interest Rates: Up (demand), Down (supply)
4) Speculation (gambling)
If a currency is Weaker are Imports/ Exports cheaper or more expensive?
Currency Weaker:
Imports more expensive
Exports cheaper
If a currency is stronger are Imports/Exports cheaper or more expensive?
Currency Stronger:
Imports cheaper
Exports more expensive
What is the relationship between Rising and falling Inflows and Outflows and Rising and falling exchange rates?
- Inflows Up/ Outflows Down } Exchange rate rises
- Inflows down/Outflows Up } Exchange rate falls
What are the consequences of excessive exchange rate movements?
It can generate uncertainty. This can hinder business planning. It can hamper current investment plans.
What are the consequences of overvalued exchange rates and undervalued exchange rates?
- Overvalued exchange rates are high rates at which exports are uncompetitive.
- Undervalued exchange rates, although giving current competitiveness to exports, raise the cost of imports. This puts upwards pressure on domestic prices and wages, and in time erode this competitiveness.
