Balance of Payments Flashcards
What are the 3 components of the Balance of Payments?
1) The current account.
2) The capital account.
3) The financial account.
What is the current account?
A record of a country’s transactions with the rest of the world.
What is the capital account?
A record of the flow of money in and out of a country from international investment transactions.
What is the financial account?
A record of the increases or decreases in a country’s ownership of international assets.
What are 4 components of the financial account?
1) Foreign direct investment.
2) Portfolio investment.
3) Financial derivatives.
4) Reserve assets.
What is foreign direct investment (FDI)?
The establishment of operations or the acquisition of tangible assets located in other countries.
What is foreign portfolio investment?
Investment in foreign financial assets, such as shares in a foreign company.
What are financial derivatives?
Contracts whose value is based on the value of an asset, e.g. a foreign currency.
What are reserve assets?
Financial assets that are available to, and controlled by, a monetary authority (e.g. the Bank of England) for the financing or regulation of payment imbalances. E.g. monetary gold.
What are 3 causes of a deficit on the current account (explain)?
1) Economic growth: As incomes grow, demand for imported goods increases, with the extent depending on YED and MPM.
2) Inflation: High domestic inflation makes foreign goods more attractive to consumers, raising imports.
3) International competitiveness: If domestic firms struggle to compete, the level of exports will fall relative to import levels.
What are 3 causes of a surplus on the current account (explain)?
1) Natural resources: If a country has large reserves of natural resources, they can run a large current account surplus.
2) Exchange rate manipulation: When the exchange rate is deliberately kept low, imports are more expensive, and exports are cheaper.
3) High interest rates: Results in more saving and less spending on foreign goods and services.
What are 4 ways to reduce a deficit on the current account?
1) Exchange rate changes: A devaluation can make exports cheaper and imports more expensive, reducing a deficit.
2) Deflationary policies: Higher interest rates will reduce spending on imports, reducing a deficit.
3) Supply-side policies: Can increase labour productivity and reduce unit labour costs, increasing international competitiveness, increasing exports and reducing a deficit.
4) Protectionism: Measures, such as tariffs, can make importing more expensive.
What is the significance of a large imbalance on the current account (3)?
1) A large and persistent deficit have to be financed, often from loans from abroad.
2) A large and persistent surplus can mean that resources are focused on meeting export demand, rather than domestic demand. This can lower consumer choice and living standards.
3) Imbalances can lead to large currency fluctuations, which can be destabilising for world trade.
