6.3 The balance of payments

doesnt include • The effect policies used to correct a deficit or surplus may have upon other macroeconomic policy objectives. • The significance of deficits and surpluses for an individual economy. • The implications for the global economy of a major economy or economies with imbalances deciding to take corrective action.

the balance of payments

a record of a countries financial transactions with the rest of the world

3 accounts under the balance of payments

current, capital and financial

components of the current account

trade in goods

trade in services

primary income

secondary income

primary income

Income from factors of production abroad

secondary income

transfer payments where no goods or services are exchanged

examples of primary income

rent earned on holiday homes abroud

intrest earned on savings from foreigners in UK banks

surplus on the current account of the balance of payments

when the value of exports plus inflows of investment income and transfres is greater than the value of imports plus the outflows of investment income and transfers

deficit on the current account of the balance of payments

when the value of imports plus outflows on investment income and transfers in greater than the value of exports plus the outflows of inversment income and transfers

state 3 factors that influence a CA deficit/surplus

productivity

inflation

exchange rate

chain of reasoning for why low productivity → worsening CA deficit

low productivity → lower output per worker → higher costs of production → less price competetive exports and foreign goods are cheaper → fall in value of exports and increase in value of imports

what does this depend on low productivity → worsening CA deficit

if producers pass on higher costs of production onto consumers as they may have large profit margins

chain of reasoning for why high inflation → worsening CA deficit

high inflation → relative prices of goods increase → price competetieness falls → value of exports falls and value of imports increases → worseinging CA deficit

what does this depend on high inflation→ worsening CA deficit

inflation is comparatively low in the economies of the country’s main trading partners

what does this depend on exchange rate appreciates → CA deficit worsens

the marshall lerner condition must be met

and the ER must have appreciated against a basket of currencies or against the country’s main trading partners

2 types of policy to reduce a deficit

expenditure switching policy

expenditure reducing policy

positives of investment flows

more capital for finacial systems in developing countries to lend

MNCs → stable employment and upskill workers

can be used to finance a CA deficit

FDI → LRAS → econ growth

joint ventures → technology transfer

Negatives of investment flows

dutch disease

profit repatriation → ofsets the initail financial account inflow

loss of economic sovreignety → less power of domestic polict

crowding out domestic firms

increases systemic risk

FDI

purchase of an asset in another country

What is the difference between portfolio investment and FDI

Porfolio investment → buing bonds and shares (short term)

fDi → building or purchasing a business and the associated infrastructure (long term)

expenditure switching policy

A policy to redirect conumer spending away from imports and towards domestic goods and services

examples of expenditure switching policies

protectionist policies

depreciating the currency

supply side policies

expenditure reducing policies

policies that reduce consumer spending on imports by reducing overall levels of consumption

examples of expenditure reducing policies

contractionary monetary policy

contractionary fiscal policy

what do expenditure reducing policies depend on

The MPM (marginal propensity to import)

if the MPM is high → greater decrease in imports when income falls → policy is likely to be more effective

policies to correct a CA surplus

appreciate the currency

expansionary monetary policy

expansionary fiscal policy

problems with depreciating a currency to improve price competitiveness

Will not correct the deficit unless the marshall lerner condition is met

imports will become more expensive → imported raw materials are more expensive → cost-push inflation → could fully cancel out the effect of a depreciation

time lag due to things like contractional obligations → deficit worsens initially

Marshall Lerner condition defenition

A depreciation in the currency will improve the trade balance only if the sum of price elasticities of imports and exports is greater than 1

how is a current account defcit financed

by attracting a net inflow on the financial account

how is a net inflow on the financial account created

increased borrowing

inward FDI

selling foreign exchange reserves

why are each of the ways in which a net inflow on the financial account created bad for the economy

governments borrow from abroad → increases national debt + intrest payments ect

finances through FDI → loss of economic sovereignty as the country’s asses are gradually being sold

selling foreign reserves → not a sustainable practice

why is a current account deficit bad

• needs to be financed (borrowing or selling assets)

• signals a lack of relative competitiveness/low productivity/low investment

• fall in AD/econ growth

• depreciating exchange rate

why is a current account surplus bad

• currency apreciation

• global imbalances that create tensions → eg trumps reciprocal tarifs based on surplus sizes

• lack of domestic consumption and potential over reliance on exports for growth

• vulnerability to external/global shocks increase

The implications for the global economy of a major economy or economies with imbalances deciding to take corrective action

One countries deficit is another surplus → if a country with a major deficit/surplus decideds to correct it → trading partners will feel their defificit/surplus effected in the opposite way