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AS Macro Revision - The Balance of Payments
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AS Macro Revision - The Balance of Payments

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Revision presentation on the balance of payments

Revision presentation on the balance of payments

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  • 1. AS Macro Revision Macroeconomics, Macro Objectives and the Circular Flow of Income Spring 2014
  • 2. www.tutor2u.net/blog/index.php/economics/categories/C59 We add new resources / links / articles every day to our Economics blogs Follow this link for the AS Macro Blog on Tutor2u
  • 3. The Balance of Payments (BoP)
  • 4. 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
  • 5. 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
  • 6. 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.
  • 7. 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)
  • 8. 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
  • 9. Balance of Payments Deficit and Surplus Countries Examples 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
  • 10. 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
  • 11. 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
  • 12. 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)
  • 13. 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 demand Import sales will CONTRACT Export sales will EXPAND When the pound depreciates against the US dollar It makes UK import prices RISE It makes UK export prices FALL
  • 14. 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
  • 15. 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.
  • 16. Get help on the AS macroeconomics course using twitter #econ2 @tutor2u_econ www.tutor2u.net