4.1.7 Balance of payments

Components of the balance of payments

Current account

• Trade in goods

• Trade in services

• Investment income

• Current transfers

Capital account

• Some capital goods

• Intellectual capital (collective knowledge within an organisation)

Financial account

• FDI

• Portfolio investment 

• Hot money 

All items could be credit / debit 

• Credit = money flowing into the country 

• Debit = money flowing out of the country 

Components of the financial account

• FDI 

• Portfolio investment = purchase of shares & bonds in other countries 

• Hot money flows = short-term money flows in & out of a country driven by speculative purposes (interest rate arbitrage (taking advantage) / currency trading)

Evaluation on why UK’s current account deficit may not be a major concern

1) UK offsets its current account deficit with financial account surplus

• = inflows of investment capital balance out payments for g&s & income flows

2) UK is a global leader in attracting financial investment due to

• strong institutions

• stable legal framework

• London’s position as a financial hub

Causes of current account surplus

• Goods & services sold abroad are very competitive due to better quality, lower price, favourable exchange rates = foreign countries want to buy more of your goods → exports increases

• Economy in recession

  • lack of demand for imports & domestic gds

Causes of current account deficit

Measures to reduce a country’s imbalance on the current account

Conclusion for using current account deficit reducing policies

• Since deficit reducing policies have negative effects

• Current account deficits should be ignored

• Unless they have arisen from serious long term reasons (ie. Structural causes)

• Even then, alternative type of policy - based on improving productivity - could be better

  • Ie. Supply-side policies

Policies to reduce a current account surplus

Significance of global trade imbalances