4.6 - Balance of payments

What is the balance of payments (BoP)?

A record of all economic transactions between residents of a country and the rest of the world over a period.

What is the current account?

Part of the BoP that records the flow of goods, services, income, and current transfers.

What is the capital account?

Records capital transfers and transactions in non-produced, non-financial assets.

What is the financial account?

Records investment flows, including FDI, portfolio investment, and reserve assets.

What are credits in the BoP?

Money coming into a country (e.g., exports, foreign investment).

What are debits in the BoP?

Money going out of a country (e.g., imports, outbound investment).

What is a current account surplus?

When inflows (credits) exceed outflows (debits) in the current account.

What is a current account deficit?

When outflows (debits) exceed inflows (credits) in the current account.

What are the four components of the current account?

Balance of trade in goods, balance of trade in services, income, and current transfers.

What is the balance of trade in goods?

Exports minus imports of physical goods.

What is the balance of trade in services?

Exports minus imports of services such as tourism, finance, and consulting.

What is the income component?

Includes wages and investment income flowing into and out of a country.

What are current transfers?

Payments with no return good/service, such as remittances or foreign aid.

What are the two components of the capital account?

Capital transfers and transactions in non-produced, non-financial assets.

What is foreign direct investment (FDI)?

Investment in physical assets in another country, such as factories.

What is portfolio investment?

Investment in financial assets like stocks and bonds.

What are reserve assets?

Foreign currency reserves held by a central bank.

What is official borrowing?

Loans taken or given by a government from or to other countries or institutions.

What is the BoP identity?

Current account + Capital account + Financial account = 0 (adjusted for reserve changes).

How are the current and financial accounts interdependent?

A deficit in one must be offset by a surplus in the other.

Why might a current account deficit cause currency depreciation?

High demand for imports increases supply of domestic currency on forex markets.

Why might a current account surplus cause currency appreciation?

High demand for exports increases demand for domestic currency.

How does the current account affect the exchange rate?

Surpluses create demand for the currency, deficits create supply of the currency.

Impacts of persistent CA deficits: exchange rate?

May lead to depreciation of the domestic currency.

Impacts of persistent CA deficits: interest rates?

May force central banks to raise rates to attract capital.

Impacts of persistent CA deficits: debt?

Can lead to increased foreign-held national debt and reduced sovereignty.

Impacts of persistent CA deficits: growth?

Lower net exports reduce aggregate demand, output, and employment.

What are expenditure-switching policies?

Policies like tariffs or currency devaluation to shift spending to domestic goods.

What are expenditure-reducing policies?

Contractionary fiscal or monetary policies to reduce overall spending.

How do supply-side policies correct CA deficits?

By improving productivity and competitiveness of exports.

Evaluate policies to reduce CA deficit?

Devaluation can worsen deficit if PEDs are low; fiscal tightening may reduce growth.

What is the Marshall-Lerner condition?

Currency depreciation improves the CA if the sum of PEDs for exports and imports > 1.

What is the J-curve effect?

Initially, depreciation worsens the CA before improving it as quantities adjust over time.

Impacts of persistent CA surpluses: consumption?

May reduce domestic consumption due to export-driven growth focus.

Impacts of persistent CA surpluses: inflation?

High export demand may cause demand-pull inflation.

Impacts of persistent CA surpluses: employment?

Can boost export sector employment but neglect domestic needs.

Impacts of persistent CA surpluses: competitiveness?

Can result in overreliance on exports; currency appreciation may erode future competitiveness.