Balance of Payments

What is the current account composed of

Capital account + Financial account

4 items in the current acount?

• Balance of Goods (Deficit)

• Balance of services (Surplus)

• Primary Income e.g. UK investment income earned abroad (+) however foreign investment income earned in UK (-) → increasingly a deficit, due to more FDI in the UK and income going out and lower returns of UK investments abroad

• Secondary income (Deficit) AID, maintenance of troops abroad

Overall, CA in deficit or surplus?

Overall a deficit since 1984

What is Capital account?

Non produced non financial assets. The capital account in the balance of payments for a country includes the effects of debt forgiveness, sale/transfer of patents, copyrights, franchises, leases and other transferable contracts across border, debt forgiveness

Quite a small account

What is financial account?

The financial account on a country’s balance of payments includes transmission

• Net balance of FDI - long term buying assets e.g. Tata buying JAGUAR LR investment/purchasing assets

• Net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity) - short term investment (stocks/bonds)

• Balance of banking flows (e.g. hot money flowing in/out of a country’s commercial banks

• Changes to the value of reserves of gold and foreign currency held at central banks

UK has high direct and portfolio investment so CAD less risky but post Brexit FDI lower and lower growth may increase risk

Reasons why a current account deficit matters?

1. X losing competitiveness

BOG deficit worsen, BOS surplus decrease, CP BOT (BOG + BOS) worsens, cp net X (X-M), AD down, negative multiplier a decrease in an injection (X) causes a more than proportionate decrease in national income, cyclical UE may increase (labour is derived demand).

However, depends how the CAD is financed, if financed by direct investment less risky as this is longer term.

If financed by hot money very risky, speculators can move funds very quickly leading to currency crises.

2. In a floating exchange rate, a lower £ should help self correct CAD

With more X and less M, £ will depreciate. Less X, demand for £ lowers. More M supply of £ increases, supply more £ to get foreign currency. When the £ depreciates, X should increase, M should decrease which should help self correct CAD with a floating exchange rate.

However, it takes 6-12 months for depreciation of £ to improve CA due to contracts being signed, PES is relatively inelastic short term.

Reasons why CA deficit doesn’t matter

1. Not concerning

Run a deficit since 1984. UK high MPM (marginal propensity to import) - more choice, competition, lower prices e.g. SHEIN, Temu, better quality e.g. tech goods. Enjoy products UK cannot produce e.g. bananas. Consumption possibility beyond original PPF, SOL up.

However, some structural UE (e.g. deindustrialisation (low skilled manufacturing), retail cannot compete, loss of call centres, some aspects IT industry. Also depends what is imported - if importing capital goods, SRAS and LRAS increase due to higher productivity. In reality, most UK imports are consumer goods, lower AD.

Policies to reduce a current account deficit (by improving X and reducing M) (explain each policy)

• expenditure switching policy (switch from foreign to UK)

• Tariff

• Expansionary monetary policy (bank rate down)

• Expenditure reducing policy (spend less on UK and foreign goods and services)

• Contractionary discal policy (income tax up)

• Contractionary monetary policy (bank rate up)