2.1.4 Balance of payments

BALANCE OF PAYMENTS

• record of all financial dealings over a period of time between economic agents of one country and all other countries

COMPONENTS OF BALANCE OF PAYMENTS

• current account- records payments for purchase and sale of g and s

• capital and financial account- records flows of money associated with saving, investment, speculation and currency stabilisation

CURRENT ACCOUNT

• trade in goods

• trade in services

• income and current transfers

CURRENT ACCOUNT- TRADE IN GOODS

• goods that are traded, whether raw materials or finished goods

• difference between exports and imports of goods is known as the balance of trade

CURRENT ACCOUNT- TRADE IN SERVICES

• services traded in or out of country

• e.g. holiday to Spain by a British is an import as money leaves the UK and goes to Spain

• balance of trade in goods and services is balance of trade + balance of invisibles

CURRENT ACCOUNT- INCOME AND CURRENT TRANSFERS

• Income and current transfers can be split into primary and secondary incomes:

  • primary income- result of loans of FOPs abroad e.g. interest, profits and dividends (including wages sent to other countries)

  • secondary income- range of mainly gov transfers to overseas organisations, such as the EU

CURRENT ACCOUNT DEFICITS AND SURPLUSES

• current balance= balance of trade + balance of invisibles + net income and current transfers

• current account surplus- where X>M, so current balance pos

• current account deficit- where X<M, so current balance neg

RELATIONSHIOP BETWEEN MEOS AND CURRENT ACCOUNT IMBALANCES

• govs have 4 main objectives:

• low unemployment

• low and stable inflation

• economic growth at a similar rate to other economies

• balance of payment equilibrium, including current account balance

• but achieving a balance of payment equilibrium can be affected by achieving other aims

• high economic growth tends to mean that the current account becomes a deficit as there is increased imports due to increased demand, and it’s during times of high unemployment etc. that current account deficit tends to improve

• govs want export led growth, which would cause economic growth, high employment and improve the current account balance; although it could lead to inflation

INTERCONNECTEDNESS OF ECONOMIES

• world economy has become increasingly interconnected, this is due to 4 key ways which have led to globalisation:

• proportion of output of an individual economy which is traded internationally is growing

• many more people (or companies) own assets in other countries such as shares, loans or businesses

• increasing migration between countries

• more tech being shared on a faster basis

INTERCONNECTEDNESS OF ECONOMIES THROUGH INTERNATIONAL TRADE

• international trade meant countries have become more interdependent so a change in the economic condition of one country will affect another, since the quantity they import or export changes

• in theory, all current balances should add up to 0 as what one country exports another imports