2.5 The Balance Of Payments Flashcards
(14 cards)
what is the balance of payments ?
the BoP records all economic tansactions between residents of an economy and the rest of the world
the BoP should balance overall, with the current account being balanced by the financial and capital account, there is also net errors and ommisions to make sure the account is balanced
what are the 3 accounts that make up the balance of payments ?
- Curent account: covers all transactions related to international trade, as well as primary and secondary income flows from abroad
- Financial account: covers transactions which result in a change of ownership of financial assets and liabilities between UK resident and foreign resisnts e.g FDI, debt and equiity, changes in gold and foreign currency reserves
- capital account: covers sale of patents, copywrights, leases
what are the components of the Current account ?
- trade balance: a measure of net international trade of G/S, records total value of exports - total value of imports
- primary income (investment income) balance: difference between total earnings received by domestic residents from assets located outside the domestic economy and total income paid out to foreign owners of assets located domestically e.g rent on foreign propert, dividend payments.
- secondary income (transfers) balance: net balance of 1-way transfers into and out of the domestic economy e.g foreign aid, remitences
what are example of things recorded in the fiancial account ?
- UK resents holding foreign bank accounts or shares in foreign companies
- foreign ownership of domestic assets
- foreigners owning UK governement bonds or holding UK bank accounts
how does economic activity in the domestic economy affect the current account ?
- increasing economic actvity in the domestic economy is likely going to increase income for residents in the UK
- this will likely increase demand for many durable normal goods e.g cars, household appliances
- many of these goods are imported from foreign economies, therefore Demand for imports increase
- this decrease the value of net exports, which will likely worsen the current account balance
- increase a CA deficit or turn a CA surplus into a CA deficit
how does economic activity in foreign economies affect the current account ?
- increasing economic activity in foreign countries will likely increase foreign household income
- this will increase the demand for UK exports
- the will increase the value of net exports in the domestic economy
- this will improve the current account balance, decrease a CA defiit or increase a CA surplus
how does the inflation rate in the domestic economy affect the current account ?
- a relativley low domestic inflation rate is likely to increase international price competitivness of domestically produces G/S
- since prices of domestic goods and services rise more slowly than prices of G/S produced in foreign economies
- this should lead to an increase in the demand for exports and an decrease in demand for imports
- this will increase the value of net exports, meaning the current account balance will likely improve
- fall in CA deficit, or increase in CA surplus
how does productivity growth in the domestic economy affect the current account ?
- higher productivity growth in the domestic economy is likely to increase the relative price-competitiveness of domestic G/S over time
- as average costs of production fall relative to other coutnries, decreasing the costs of domestic G/S realtive to other countries
- this will lead to increase demand for domestic exports and fall in demand for imports.
- increasing the value of net exports, meaning current account balance will likely improve
- fall in CA deficit, or increase in CA surplus
d
how does exchange rates affect the current account ?
- a fall in the exchange rate (depreciation) will likely increase the relative international price competitiveness of domestically produced G/S
- since domestic goods appear cheaper to foregn buyers
- also foreign goods appear to be more expensive to domestic households
- increasing external demand for exports and decrease demand for imports
- this will increase the value of net exports and likely improve the current account balance
- CA deficit will reduce, CA surplus will increase
What are the consequences of a CA deficit? Pt1
1) downward pressure on the exchange rate - caused by a fall in demand for the domestic currency as well as an increase in the demand for foreign currency, since imports are greater than exports
2) reduced foreign exchange reserves - this is a problem since central bank hold foreign reserves to maintain the exchange rate
3) increased foreign ownership of domestic assets - CA deficit needs to be offset by a financial account surplus, this means in the future, further outflows of income from the domestic assets, this may increase the CA deficit in the future
What are the consequences of a CA deficit? Pt2
4) loss of domestic sovereignty, if there is increasing foreign influence on decisions in the domestic economy, e.g China in west Africa
5) possible increase in foreign indebtedness - due to increased foreign borrowing. This could lead to increasing costs of external debt servicing
6) negative impact on international credit rating, due to a possible increase in perceived risks and uncertainty for creditors
what are the advantages of a current account surplus ?
- CAS means net exports > 0, and there is higher domestic prodsuction and greater GDP and employment
- Uuseful for developing countries - growth can be export led even if doemstic consumption is low due to low incomes e.g china 30 years ago
- CAS means deficit on financial account, this ownsership of foreign financial assets will likley lead to increase primary income inflows in the future
what are the disadvantages of a current account surplus ?
- Higher AD due to high exports and therfore net exports may be inflationatry
- domestic economies are reliant on foreign demand for domestic exports, subject to economic shocks in foreign economies
- financial account deficit means there is not much FDI in the domestic economy, in the long run this could lead to lower long run economic growth .
What does the significance of the CA (deficit or surplus) depend on ? Pt1
- the size of the CA deficit or surplus: the larger the deficit, the larger the outflow of income from the domestic economy, which could have been spent on G/S produced in the domestic economy, additionally the larger the deficit the more international borrowing may be required to finance the deficit
- duration - how long the CA imbalance persists for: in the short term, a CA deficit may be a sign of rising living standards, however in the long run it may reflect a lack of international competitiveness
- the cause of the CA imbalance: structural weakness and a lack of price-competitiveness possibly due to low productivity growth are likely to be far more damaging to an economy since there will be a decrease in SRAS causing inflationary pressure, however if the deficit is due to importing capital goods this can increase productive capacity in the long run, possibly increase competitiveness and correct the CA deficit over time.
