Post on 17-Aug-2014
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AS Macro Revision
The Balance of Payments
Spring 2014
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The Balance of Payments (BoP)
The Balance of Payments
For AS economics emphasis is on the current account of the BoP and in particular the balance in trade in goods and services
• The balance of payments (BOP) records all financial transactions made between consumers, businesses and the government in one country with other nations
• Inflows of foreign currency are counted as a positive entry (e.g. exports sold overseas)
• Outflows of foreign currency are counted as a negative entry (e.g. imported goods and services)
• The current account of the balance of payments is the main measure of external trade performance
Items in the Current Account of the BoP
• Finished manufactured goods, components, raw materials
• Energy products, Capital technology
Trade Balance in Goods
• Banking, Insurance, Consultancy• Tourism, Transport, Logistics• Shipping, Education, Health,• Research, Cultural Arts
Trade Balance in Services
• Overseas aid / debt relief• Private money transfers e.g. From migrants
Net Money Transfers
• Profits, interest and dividends from investments in other countries e.g. The profits from transnational businesses
Net Investment Income from
Overseas Assets
Worked Example of the BoP Current Account
Item of the Balance of Payments Net Balance$ billion
Current Account (1) Balance of trade in goods -25
(2) Balance of trade in services +10(3) Net investment income -12(4) Net overseas transfers +8
Sum of 1+2+3+4 = Current account balance -19
The current account comprises the balance of trade in goods and services net investment incomes and net transfers.If a country is running a current account deficit, there is a net outflow of demand and income from the circular flow.
Causes of a Balance of Payments Deficit
• Higher inflation than trading partners• Low levels of capital investment and research• Weaknesses in design, branding, performance
Poor price and non-price competitiveness
• High currency value increases prices of exports• Appreciating currency also makes imports cheaper
causing switch of demand to them
Strong exchange rate affecting exports and
imports
• Recession lowers exports to countries affected• Might be barriers to switching to other markets
Recession in one or more major trade partner countries
• Exporters of primary commodities might be hit by a fall in world prices of their major export products
• Importing nations could be hit by higher prices for essential goods
Volatile global prices (e.g. Commodities)
The Export Multiplier Effect
A fall in exports will reduce AD and the final impact on GDP, jobs and investment is amplified by multiplier and accelerator effects
Real GDP
GPL1
Y1
AD1
AS
Y2
AD2
GPL2
GPL The Export Multiplier Effect
Many industries rely heavily on key export industries remaining competitive – these include:
• Transportation / freight / logistics businesses
• Trade finance businesses e.g. Insurance and trade credit
• Service businesses that operate in ports and airports
Exports particularly important for regional economic performance
Balance of Payments Deficit and Surplus CountriesExamples of Countries that run
Current Account Deficits
Current account, % of GDP, data is 2012, Source: World Bank
Mongolia -49.5
Cyprus -22.3
Jamaica -11.4
Ghana -8.6
Portugal -5.0
South Africa -4.6
Sri Lanka -4.4
India -3.6
Examples of Countries that run Current Account surpluses
Current account, % of GDP, data is 2012, Source: World Bank
Kuwait +39.7
Saudi Arabia +31.8
Norway +18.2
Singapore +17.7
Switzerland +13.9
Taiwan (China) +8.1
Germany +5.3
China +3.1
Economic Problems from Persistent Trade Deficits
Loss of aggregate demand which causes slower real GDP growth and reduced living standards
Loss of jobs in home-based industries, may contribute to regional decline and structural unemployment problems
Can lead to currency weakness and higher inflation and a country may run short of vital foreign currency reserves
Trade deficit might be a reflection of lack of competitiveness / supply-side weaknesses
Possible Problems from Running Trade Surpluses
If GDP is close to capacity, a rise in the trade surplus might cause demand –pull inflation
Persistent trade surpluses might lead to threat of protectionism from trade deficit nations
If the surplus is due to high saving / low consumption, living standards might be too low
Surplus might be result of exporting high-priced commodities – prices are volatile/unpredictable
Economic Policies to Reduce a Trade Deficit• Demand management: A tightening of fiscal and/or monetary
policy reduces real spending power of consumers and leads to lower spending on imports (fall in M improves trade balance)
• Lower exchange rate reduces the overseas price of exports and makes imports more expensive – causes changes in demand
• Supply-side improvements: • Policies to raise labour productivity and encourage start-
ups with export potential e.g. Life sciences, digital etc• Investment in human capital to boost productive capacity
and competitiveness in high-value industries such as bio-technology, engineering, medicine, tourism
• Protectionist measures such as import quotas and tariffs (NB: limited by global trade agreements e.g. EU and WTO rules)
Economic Effects of a Currency Depreciation
This will have an effect on a number of economic indicators
Domestic production Trade deficit Domestic jobs
Changes in import and export prices will affect demandImport sales will CONTRACT Export sales will EXPAND
When the pound depreciates against the US dollarIt makes UK import prices RISE It makes UK export prices FALL
Will an Exchange Rate Depreciation improve the BoP?
Time period after depreciation
Trade surplus
Trade deficit
Currency depreciation
here
Trade deficit may grow in initial period after depreciation
Net improvement in trade provided certain conditions
are met
The diagram below shows the “J Curve effect” – it shows the time lags between a falling currency and an improved trade balance
Some Reasons for the UK’s Persistent Trade Deficit
High income elasticity of demand (Yed) for imported goods and services
Some weaknesses on supply-side of the economy (i.e. Low research / investment)
Many UK businesses finding it hard to finance a rise in exports (effects of credit squeeze)
The majority of our exports go to slower-growing countries in Europe e.g. Ireland, Spain and also the USA. Less successful in exporting to BRICs.
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