6.4 - Current account and balance of payments Flashcards
What is the Balance of payments?
The record of all economic transactions (individuals, firms gov) between one country and the rest of the world over a time period .
What is the current account?
Shows the income earned by the country and the expenditure made by its dealings in other countries
What are the 4 components of the current account?
Primary income: Wages, salaries, profit , dividends and interest receipts earned b residents working abroad minus that earned by foreigners working in the home economy
Trade in goods: Visible trade goods such as cars manufacturing food machinary
Trade in services: Invisible trade services like banking construction services financial services travel and transportation
Secondary income: Money, goods or services which are sent out of the country or come come into the country, not in return for anything else like gifts workers.
How could a country have a trade in goods surplus but a deficit on the current account account on the balance of payments?
Trade in good surplus means that the exports of goods exceeds the imports of goods
However the trade in good services in only one part of the current account, as it is also made up of trade in services primary income and secondary income
Therefore there could be a larger deficit on the trade in services balance which would outweigh any surplus in trade in goods
What is a current account deficit, surplus and balance?
Current account deficit: A country is importing more goods and services than it is producing.
Current account surplus: A country is exporting more goods and services than it is importing.
Current account balance: A country is exporting the same amount of gods and services as is it importing.
What are the causes of a current account deficit?
Relatively low productivity - This raises cost and exporting firms may find themselves at a price and cost disadvantage in the overseas market, decreasing cometitiveness.
Relatively high value of the country’s currency - this makes a country’s exports more expensive and imports cheaper in relation to other nations
Relatively high inflation rate - goods and services are cheaper in other countries and therefore more attractive to both foreign and domestic buyers
Rapid economic growth - A rise in household income allows consumers to purchase goods and services from abroad
Non price factors- When a country develops a reputation for poor quality and design, its exports fall as foreign buyer look for better substitutes.
What are causes of current account surpluses
Relatively high productivity - High productivity decreases costs
Exporting firms with high productivity may find themselves at a price & cost advantage in overseas markets which will increase competitiveness & the level of exports
Relatively low value of the country’s currency - Currency depreciation makes a country’s exports less expensive relative to other nations
Foreign buyers increase their purchases & the level of exports rises
Similarly, currency depreciation makes imports ,ore expensive
Domestic consumers may switch demand to locally produced products & the level of imports falls
Relatively low rate of inflation - A relatively low rate of inflation makes a country’s exports less expensive than other nations
Foreign buyers increase their purchases & the level of exports rises, improving the balance on the current account
What are consequences of a current account deficit?
Increasing unemployment: with falling demand for locally produced goods/services, fewer workers will be required & unemployment will rise
Slow down in economic growth or a recession: exports are a key component of the real GDP of many countries & a fall in exports may significantly reduce the level of economic growth
Lower standards of living: a fall in economic growth usually leads to a reduction in wages which leads to a decrease in the standards of living
Increased levels of borrowing: if the deficit is caused by continually increasing levels of imports, then it is likely that these imports are being paid for through higher levels of borrowing
Depreciating exchange rate: while this may ultimately help to increase exports again, it makes the cost of imported goods/raw materials more expensive and may cause cost push inflation
What policies can stabilise the current account balance?
They could use expenditure switching policies. These include:
* Protectionist policies which raise the price of imports, so consumers switch to buying domestic goods
* Currency devaluation which makes the price of imports more expensive & so consumers switch to buying domestic products
They could use expenditure reducing policies. These include:
* Raising taxes which cause consumers to have lower disposable income & so they spend less on imports
* Raising interest rates which reduces the level of borrowing resulting in a fall in the level of imports
They could use supply-side policies. These include
* Investment in education which raises productivity making exports cheaper & more attractive
* Investment in infrastructure which lowers costs for firms making exports cheaper & more attractive
What are the advantages and disadvantages of expenditure switching?
This is often successful in changing the buying habits of consumers, switching consumption on imports to consumption on domestically produced goods/services. This helps improve a deficit
Any protectionist policy often leads to retaliation by trading partners. This may consist of reverse tariffs/quotas which will decrease the level of exports. This may offset any improvement to the deficit caused by the policy
What are the advantages and disadvantages of expenditure reducing?
Contractionary fiscal policy invariably reduces discretionary income which leads to a fall in the demand for imported goods & improves a deficit
Contractionary fiscal policy also dampens domestic demand which can cause output to fall. When output falls, GDP growth slows & unemployment may increase
What are the advantages and disadvantages of supply side policy?
Improves the quality of products & lowers the costs of production. Both of these factors help the level of exports to increase thus reducing the deficit
These policies tend to be long term policies so the benefits may not be seen for some time. They usually involve government spending in the form of subsidies & this always carries an opportunity cost
How does a current account deficit harm the economy?
Income is leaving the country, reducing aggregate demand. Consequently, there is a reduction in economic growth which means there will be less demand for labour, worsening unemployment
There will be a downward pressure on the exchange rate, due to more domestic consumers selling their currency. Eventually this make exports cheaper and imports more expensive, both of which will worse th inflation rate
How does a current account deficit benefit the economy?
A current account deficit may be cyclical and occurring during an economic boom. When consumers have more disposable income to spend on imports. This means that the balance of payments may improve when the economy slows
Developing countries need to import raw materials and capital in order to be able to increase output in the future and ensure economic growth, and therefore won’t see a current account deficit as harmful to their economy
How does a current account surplus benefit the employment rate?
More export means that more output is needed, which means that more workers will be needed as demand for labour is a derived demand.
A surplus means that there is more money flowing into the economy, increasing aggregate demand and economic growth, which could generate more jobs within the economy
