Paper 2 Global Economy

Balance of Payment

record of the value of all the transactions between the residents of one country and the residents of all other countries in the world over a given period of time.

Three Main Accounts

1. Current Account

2. Capital Account

3. Financial Account

CREDIT (Positive Value +)

Any transaction that leads to an inflow of money from abroad into the country account.

DEBIT (Negative Value -)

Any transaction that leads to an outflow of money from the country into a foreign country's BOPs.

DOUBLE-ENTRY SYSTEM

It is a double bookkeeping system where every credit on the BOPs corresponds directly to a debit.

Balance of Goods

Refers only to tanginble goods. Expor Revenue - Import Expenditure (Goods only)

CREDIT vs. DEBIT

Inflow (+ Export Revenue) vs. Outflow (− Import Expenditure)

SURPLUS vs. DEFICIT

Exports > Imports (Surplus) vs. Exports < Imports (Deficit)

Balance of Services

Calculated the same way as goods, but exclusively in relation to services.

Examples:

• Banking, Architecture… [ Task: Give 3 more examples ]

Trade Balance Equation

Export Revenue – Import Expenditure = Trade Balance (Surplus or Deficit)

Export Revenue: Money earned from selling domestic goods and services abroad (inflow/credit for the economy)

Import expenditure: Money spent on purchasing foreign goods and services (outflow/ debit for the economy)

Net Income

net investment income or factor income from abroad. Measures money movements from international investment in and out of the country.

1. Profits(Earnings from foreign direct investments and overseas operations.)

2. Interest Payment (Returns on loans, bonds, and international debt instruments.)

3. Dividend (Payouts distributed to foreign equity holders and investors)

Current Transfer

net unilateral transfers from abroad. Monies moving across borders when no goods or services are exchanged in return.

1. Remittances: Workers sending wages to family back home.

2. Foreign Aid: Official development assistance and disaster relief.

3. Grants & Gifts: Non-repayable funds and cross-border gifts.

Remittances

Money sent across national borders to cover basic living expenses, housing, education or healthcare

• Support for Developing Nations: Remittances serve as a crucial economic lifeline, boosting household income and national reserves.

• Poverty Reduction Tool: Direct capital transfers empower families to afford healthcare, education, and basic necessities.

Current Account Equation

Balance of trade in goods + balance of trade in services + net income flows + net transfer

Asset Transactions in BOP

Measures the international buying and selling of assets across borders.

Key Asset Categories:

Real estate, land, company equity, bank deposits, stocks, government bonds, foreign currency, and financial derivatives.

Capital/Financial Account Dynamics

Tracks the net change in foreign ownership of domestic assets vs. domestic ownership of foreign assets.

Capital Account Surplus:

Occurs when foreign ownership of domestic assets (credit/inflow) increases faster than domestic ownership of foreign assets (debit/outflow).

Capital Transfer

A minor part of the account measuring net monetary movements from cross-border asset transfers.

They transfer asset ownership without a direct monetary exchange. However, Increases a country's capital Stock and wealth.  

Key Components:

Transfer of fixed production assets, and debt forgiveness.

Non-Produced, Non-Financial Assets

Transactions in natural resources and rights, alongside intangible marketing & intellectual assets.

Key Asset Categories:

Land and rights to natural resources, plus intangibles like patents, copyrights, trademarks, and brands.

Inttangible Asset Significance

Intangible assets such as corporate brand equity, patents, and copyrights constitute a major share of modern corporate valuation and international balance sheet exchanges.

1st Component: Direct Investment (FDI)

Core Definition:

Purchases by Multinational Corporations (MNCs) of long-term assets in a foreign country to gain a lasting interest in a enterprise.

Practical Examples:

• Setting up production facilities in overseas locations

• Expanding operations by acquiring machinery & buildings

• Direct capital investments in foreign business entities

2nd Component: Portfolio Investment

A measure of stock and bond purchases (not leading to a lasting interest). Government bonds and bank deposits would be included here but usually listed as “other investments”.

3rd Component: Official Borrowing

Government borrows rather than private individuals, households or firms. Gov often borrows from creditors like IMF.

4th Component: Official Reserve Account

Gold and foreign currencies held by countries. Movements in this account assure that the overall balance of payments always balances to zero.

Exchange Rate

The value of one currency expressed in terms of another, or against a basket of currencies.

Traded on the Foreign Exchange Market (FOREX) centered in primary global financial hubs:

• New York • London • Zurich
• Frankfurt • Tokyo

Factors affecting Demand of currency

• Interest Rates: Higher returns attract foreign capital.

• Demand for Goods: Appetite for exports drives currency needs.

• Foreign Incomes: Rising income abroad increases local export buying.

• Investments (FDI & Portfolio): Inflows require local currency.

• Remittances & Protectionism: Capital transfers & trade policies shift demand.

Factors affecting Supply of currency

• Think Domestic: Consumers hold local currency to begin with, but may get rid of or sell it.

• Consumer Impact: Domestic consumers have a major effect on the currency. Who else?

• Central Bank Action: The Central Bank could increase supply by ________.

• Selling Motivation: What will make domestic consumers sell their currency?

• FOREIGN INVESTMENT!!

• Government Bonds: Buying them increases money supply.

• Interest Rates: Lowering them encourages investing overseas.

• Import Purchases: Requires foreign currency to buy goods & services.

• Foreign Investments: Portfolio Investment or FDI outbound.

• Currency Speculation: Buying foreign currency seeking profit.

• Income Growth: Higher domestic income boosts overall consumption.

• Domestic Inflation: High inflation shifts purchasing behavior.

• Remittances: Capital flows moving into/out of the country.

• Tariff Policy: Lowering tariffs alters import demand & supply.

• Foreign Reservies

Depreciating Exchange Rate Consequences

Cheaper to Foreign Buyers: UK exports appear to be cheaper in foreign markets.

Increased Competitiveness: Lower relative prices drive up global demand for UK goods and services.

More Expensive in the UK: Imports to the UK appear more expensive to consumers.

Reduced Demand: Higher prices deter domestic buyers, leading to a drop in total imported goods.

Types of Currency Regimes

Floating Exchange Rate - Driven Purely by market forces of supply and demand without direct central intervention

Managed (Dirty Float) - Monetary Authorities interven within established targetbands to buffer against extreme volatility (Government Intervention Mandate - The government will have to steer the market forces of supply and demand to maintain this fixed peg.)

Fixed/ PEgged rate - Value is explicity tied to a benchhmark like the US dollar

How to manage currency

Interest Rates, Foreign Reserves, Bonds & Open Market Ops, Printing Money?

Interest Rates

Adjusting policy rates to influence short-term capital flows, credit expansion, and overall currency demand.

Foreign Reserves

Buying or selling foreign currency holdings in international markets to counter unwanted currency swings.

Bonds & Open Market Ops

Issuing or purchasing government securities to regulate domestic market liquidity and yields.