2.1.4: The Balance of Payments

What is the Balance of Payments (BoP)?

A record of all financial transactions between a country and the rest of the world over a period of time.

What are the four components of the Current Account?

Trade in goods,Trade in services,Primary income,Secondary income

What is the Balance of Trade?

The difference between exports and imports of goods and services (X – M).

What is a Current Account deficit?

: When imports are greater than exports → money flows out of the economy.

What is a Current Account surplus?

When exports are greater than imports → money flows into the economy.

why might current account deficit be a problem?

Higher foreign debt if the country borrows to finance the deficit

Loss of domestic jobs if imports replace local production

Pressure on the exchange rate (currency may weaken)

How does economic growth affect the Current Account?

Growth increases income → more imports → worsens deficit.

What is the conflict between unemployment and the Current Account?

Policies to reduce a deficit (e.g. higher taxes) reduce AD → increase unemployment.

How does inflation affect the Current Account?

Lower inflation → exports more competitive → improves balance.

What is financial contagion?

Economic shocks in one country spreading to others due to global financial links.

Why might a Current Account deficit not be a problem?

• Small size

• Temporary (cyclical)

• Financed by investment

• Used for capital goods (boosts future growth)

Why might a Current Account deficit be a problem?

• Large and persistent

• Poor competitiveness

• Selling domestic assets (“selling the family silver”)

• Caused by consumption, not investment