Balance of Payments (recap) =a record of payments between one country and the rest of the world The Current Account of the BOP records transactions that are income for the recipient, rather than investments or loans
Current Account – records:
1.Trade in Goods and Services
Measures the movement of tangible products across international borders (UK large exporter of pharmaceuticals but a major importer of foodstuffs and oil and gas) and the movement of intangible product (UK major exporter of banking and insurance services but an importer of foreign holidays)
2. Investment Income – measure of interest, profit and dividends that are rewards for capital investments in another country. E.g. if a UK person buys shares in a US company the shares will not appear on the current account but any dividends will appear as a positive figure on the UK current account and
3. Transfers – the movement of funds for which there is no corresponding trade in goods and services. E.G. Taxes paid to the EU, membership fees of UN, IMF – payments to British Military personnel working in another country – and when economic migrants send some of their incomes back to their families in another country.
Surplus / Deficit
A country like Germany, exports a large number of high-value goods, has a surplus on the current account – more money flows in that flows out.
A country that enjoys a high living standard and a high level of confidence (net exports are negative) is likely to be running a deficit. E.g. USA, UK.
On its own, a BOP deficit on current account is not a problem for an economy as long as it can be funded, but it becomes a problem as reserves of foreign currencies begin to run low. It might mean that the currency falls in value, which is inflationary. Why does this happen? It might be a sign that the country is becoming uncompetitive – Explain . And might in the long run mean that a painful readjustment, such as tax increases, is required to stop people overspending.
Causes and Costs of an Imbalance Common Exam Error – when interest rates rise ‘hot money’ enters the country – this does not affect the Current Account Balance as this part of the accounts only record incomes. When interest rates rise the exchange rate usually rises as well – this makes us less competitive…. X-M change.
- Only significant when the deficit (or surplus) becomes unsustainable. What is this?
Persistent deficits can make the value of a currency fall, so in some economies the government might try to buy up surplus currency in order to maintain its value. (Not the UK)
A fall in the value of the currency may restore competitiveness.
Persistent deficits see net incomes leave the country, which might mean demand in the domestic country.
Can cause unemployment (which for the MPC might mean that the onset of inflation is prevented.
Country is spending too much, or that it is not producing anything that potential customers abroad want to buy.
It may be because of the stage in the business cycle, which clearly may be different for different countries at different times.
Or the strength of the currency – if sterling is strong against the dollar, the UK is likely to export less and import more.
- due to loss of competitiveness in the manufacturing sector owing to higher costs of factors of production in the UK relative to the Far East. It takes time for economies to adjust to changing comparative costs, and during the adjustment process the UK is likely to face an ongoing deficit
Balance of Payments 12 Balance of Payment and BOP Theory 11 Understanding the Current Account Understanding the Capital Account Read Wiki on BoP and take notes – and use the link to the financial crisis of 2007-2010