Theme 4 Flashcards
3 sections of the BoP
Current Account, Capital Account, Financial Account
Areas of the current Account
Balance of trade in goods, balance of trade in services, net primary income, net secondary income
Areas of the capital account
Transfer of ownership of fixed assets, sale/transfer of patents
Areas of the Financial Account
Net balance of FDI, balance of banking flows, changes to value of gold reserves
What must the BoP always be?
Final value of 0
Reasons for surplus and deficit is
Uneven distribution of natural resources, differential competitiveness, inflation, domestic and government spending
Reasons for a current account deficit
Poor price and non-price competitiveness, strong exchange rates effecting demand for imports and exports, recession in one or more trade partner countries, volatile global prices
Structural causes of a current account deficit (long-term)
Under-investment, relatively low productivity, persistently high relative inflation, inadequate r and d, emergence of lower cost competition
Cyclical causes of a current account deficit
Over-valued exchange rate, boom in domestic demand, recession in key export markets, slump in global prices of exports, increased demand for imported technology
Recession
2 consecutive quarters of negative growth
Significance of a current account deficit
Outflow of AD on circular flow of income, drag in GDP growth, loss of jobs in export sectors, fall in foreign exchange reserves, weakened exchange rate
Difference between Fiscal and Trade deficit
Fiscal - government debt, Trade - Current Account deficit
Consequences of a current account deficit
Lowers AD, debt burdens, worsens exchange rate
How is Lower AD a consequence of a current account deficit?
Lowers demand, which lowers growth and increases unemployment
How are debt burdens a consequence of a current account deficit?
To balance deficit, countries must have a financial account surplus. To gain a surplus, countries sell bonds and use hot money, which causes issues as doesn’t help the current account deficit and as debut increases, other countries lose confidence as don’t receive money back
How is a worsening exchange rate a consequence of a current account deficit?
Large amount of imports mean more countries gain the pound, so the supply increases which worsens the exchange rate
Expenditure switching policies
Exchange rate, protectionism, deflationary, supply-side, government investment in industry
Deflationary Policy
Tight Fiscal and Tight Monetary Policy - leads to a drop in import demand
Benefits of Supply-Side Policies
Drop in prices, exports more competitive
Methods to increase supply
Training, subsidies, education, machinery
3 areas of supply-side policy
Increase size of labour force, increase productivity, increase efficiency of business
Issues of tight monetary and tight fiscal policy
Conflict of objectives, high consumer and business confidence, output gap ( full employment), inelastic imports
Protectionism
Taxes on imports (tariffs), banning imports (embargo’s), only import a certain amount (quota), increase Uk production(domestic subsidies)
Problems of protectionism
Other countries will retaliate, non-price factors, inflationary issues, WTO rules, loss of efficiency
Exchange rate policies
Loose monetary ( weakening interest rates), selling £ or buying foreign currency, increase money supply ( Quantitative Easing )
Problems of exchange rate policies
Liquidity Trap, non-price competition, currency wars
Marshall Learner Condition
Devaluation of a currency will only improve BoP if sum of the prices elasticities of its imports and exports are greater than one
J-curve reasonings
Long-time change ( buying on a national scale), imports get more expensive before exports get cheaper
Reasons why a current account deficit doesn’t matter
Capital flows (improve financial account), partial auto correction ( pound weaken anyway if importing more than exporting) , Internal correction ( investment and supply-side policies)
Reasons why a current account deficit matters
Reliance on trade, unbalanced economy, issued financing debt, loss of output and employment, downward exchange rate pressure
Reasons for a Current Account Surplus
Export orientated growth, FDI, under-valued exchange rate, productive efficiency, closed economy, new resource discoveries
Consequences of a current account surplus
Inflation, financial account deficit, appreciate the exchange rate, reliance on exports, harm international relations
Spot Exchange Rate
Rate for a currency at today’s market prices
Forward Exchange Rate
Fixing a rate for a currency up until a certain period of time (more businesses)
Bi-Lateral Exchange Rate
Rate at which one currency can be traded against another
Floating Exchange Rate
Value is determined by demand and supply for the currency
Advantages of a floating exchange rate
Stability in Bop, unrestricted foreign exchange, enhance market efficiency, import inflation protected, freedom for domestic monetary policy
Limitations of a floating exchange rate
Exposed to volatility, restricted economic growth, loss of exchange rate as policy tool
Fixed Exchange Rate
Value of the currency is fixed
Advantages of a fixed exchange rate
Doesn’t suffer from volatility, unrestricted export growth, maintain low inflation levels, reinforces gains in comparative advantage, higher confidence for importers/exporters
Limitations of a fixed exchange rate
Lack of flexibility to external economic shocks, BoP issues, dependence on reserves, currency could be overvalued
Managed-Floating Exchange Rate
When a Central Bank may choose to intervene in the foreign exchange market to affect the value of a currency to meet specific macroeconomic objectives
Advantages of a managed-floating exchange rate
Economic stability,monetary autonomy, trade competitiveness, risk diversification, improve export competitiveness, control demand-pull inflation, reduce import prices
Intervention for a depreciation of a currency
Expand QE to stimulate money supply and lower bond yields. Government buy assets from overseas, return on FDI falls so countries take money out
Intervention for appreciation of currency
Reduce taxes on income from assets to attract overseas investors to buy a currency
Limitations of a managed-floating exchange rate
Requires large-scale foreign exchange reserves, bank have no power against global economies, conflict of objectives
Reasons for government spending
Efficiency and market failure, equity and equality, macroeconomic management
Current spending
General government financial consumption I.e NHS wages, road’s maintenance
Transfer Payments
Any benefits/pension - transferring payments to reduce inequality
Current government expenditure
Central government final consumption + debt
Crowding out definition
Increase in government spending, government sells bonds which private sector buy, to buy back the bonds which come from private investment - money shifts from private to public
Crowding in definition
Increased government spending, increased confidence, increased private investment
Progressive Tax
Marginal rate of tax increase as income rises (I.e Income Tax)
Proportional Tax
Marginal rate of tax is constant leading to a constant average rate of tax ( NICs )
Regressive Tax
Rate of tax paid falls as income rises ( I.e alcohol duty )
Direct Tax
Taxes on individuals and companies
Indirect Tax
Taxes on goods and services
Laffer Curve
Shows how if taxes is increased too high tax revenue falls as it encourages tax evasion
Cyclical Fiscal Balance
The size of the fiscal deficit is influenced by the state of the economy ( in a recession, tax revenue falls and transfer payment spending increases ) and vice-versa
Structural social deficit
Size of the deficit isn’t influenced by the state of the economy ( pension payments increasing due to an ageing population )
Uk budget Deficit ( Application )
Long-term ( 26% borrowed for 15 years + )
28% of debt linked to inflation
Government never failed to repay a debt
Average return on Uk debt is 17 years ( 10 year more than G7 countries )
How is the Uk deficit sustainable?
Yield in bonds gone down, government can borrow for 10 years between 0.5 - 1 %
Public sector debt
Debt owed by central/local government and public corporations
Private Sector Debt
Debt owed by private businesses and households
Problems with high government debt
Interest on debt, higher taxes, low confidence, less FDI, worsens exchange rate
Solutions to high government debt
Raise taxes, spending cuts, privatisation, supply-side policies
Reasons a debt isn’t an issue
Required to fund critical infrastructure, inevitable when an economy experiences a sever external shock ( Brexit/Covid ), rational to borrow when yields are low, foreign investment on bonds, borrow to stimulate economy
Transfer Pricing
A method of pricing goods and services transferred within a multinational or trans-national company in order to avoid tax burdens and maximise profits
Arms Length Principle
Stating that each business in each country should be individual and the profits they state should match the conditions of the country
Globalisation
The interdependence of world economies for trade
Footloose definition
When big MNCs move to nations for cheap labour and tax reasons
Impact of globalisation on UK
Increased employment,increased migration, increased wages, increased choice/availability, increased specialisation, less sustainable
Absolute Advantage
Being able to produce more of something than another country
Comparative Advantage
Being able to produce something at a much lower opportunity cost than another country
Terms of trade
How many exports we have to sell to pay for our imports
Terms of Trade equation
Index of export prices/Index of import prices x 100
Factors influencing cost of imports and exports
Exchange rate, inflation, productivity, elasticity
Free Trade Area
Free trade between members, can have different trade barriers with outside country
Customs Union
Free trade between members, must have same trade barriers with outside country
Common Market
Customs union with even more freedom between member countries
Full Economic Integration
Governed by one body (UK)
Monetary Union
Share currency, central bank and monetary policies
Benefits of a Trading Bloc
Economies of scale, all provide different benefits, forces firms to compete, increased FDI
ASEAN
Economic Union of 10 south-east Asian countries aimed at promoting economic growth and regional stability amongst its members
Disadvantages of a trading Bloc
Competition for weaker members, interdependence, loss of sovereignty
World Trade Organisation
Seeks to reduce trade barriers, create world trade rules, resolve disputes
Positives of the WTO
Promotes free trade, provides trade stability, promotes economic development, allows developing nations to benefit from economies of scale, promotes fair competition
Protectionism
Protecting your domestic markets from foreign goods or services
Tariff
An excise tax on specific imported goods
Gina-Coefficient
Area under A divided by Area under A+B ( larger find-coefficient, more inequality )
Harold Domar Model
Increased investment - Higher capital stock - Higher economic growth - Increased savings
Capital-Output Ratio
A lower capital-output ratio means investment is more efficient and the growth rate will be higher
Criticisms of the Harold- Domar Model
Difficult to increase savings, assumes the existence of a reliable finance and transport system, increase in inequality
International Aid
Any form of needed assistance by one country, or multinational institution, to another
Reasons for Aid
Reduces inequality, moral responsibility, future trade opportunitws
Debt Relief
Cancelling the debt of developing countries
HIPC
Heavily indebted poor countries initiative ( aid when countries debt to government revenue exceeds 280%)
Problems of debt relief
Encourages countries to borrow and not pay back, no legal obligation on private creditors to cancel debt
The Lewis model
Movement of surplus unproductive labour from rural areas to cities - movement to a services related economy
Micro finance
Provision of small scale loans to promote enterprise ( often given to women )
Benefits of micro finance
Entrepreneurship, tax revenue, reduces inequality, improved rural economy, job opportunities
Problems with micro finance
High interest rates, money wasted if lack business skills, opportunity cost, banks lose money, small loans
FDI
When a global firm sets up a factory or makes an ownership investment in another country
Problems of FDI
Use up resources, reduces competition ( monopoly power ), over dependence on FDI, exploitation of workers
The World Bank
An international financial institution that provides loans to countries of the world for capital programs
IDA
International Development Association - works with poorest countries ( average GDP under 888 dollars a year )
How the World Bank helped Africa
Addressing climate crisis, infrastructure investment, food aid, regional integration, education aid
Criticisms of the World Bank
Not-elected, corruption, long-term strategy, over dependence on loans
Measures the IMF take
Cut pensions, raise income tax, raise retirement age, decrease minimum wage
Criticisms of the IMF
Conditions of loans, exchange rate reforms, privatisation reforms, lack of free market, moral hazard
Red Cross
Respond to international emergencies, provide short-term relief, humanitarian aid
Benefits of red aid
Experienced and responsive, no political agenda
Criticisms of red aid
Small amount compared to UN, patronising, unelectedm
Financial market
Any place or system that provides buyers and sellers their means to trade ( Bank of England )
Role of Financial Markets
Facilitate savings, lend to businesses and individuals, facilitate the exchange of goods/services, provide forward market in currencies, provide a market for equities
Market failure in a financial market
Asymmetric information, moral hazard ( banks get bailed out ), adverse selection ( selling to unworthy buyers), market rigging, externalities, speculation
Financial Conduct Authority ( FCA )
Regulators in financial market, micro-credential ( protects consumers ), bans collusion, promotes competition in banking, bans misleading products/adverts
Prudential Regulation Authority
Micro-credential regulators, maintain stability of banks, monitor management of bank-taking risk,specify requirements banks to meet
Financial Policy Committee (FPC)
Manages entire financial sector, advises government of upcoming risks, carries out stress tests
