Balance of Payments

The Balance of Payments records money flows into and out of the country in a given time period.

What is it made of

Three parts:

  • The Current Account - The largest part
    • Trade in goods and services
    • Income
    • Transfers
  • The Financial Account
    • F.D.I
    • Hot Money
  • The Capital Account
    • Land

Flows of money between economies

Credit: The current account is credited when money flows into it from abroad

Debit: The current account is debited when money flows out from the UK to abroad.

Exports -> Credit
Imports -> Debit

Current Account

Total Trade

Records the value of exports and imports of goods and services.

Examples:

  • Credit: Exporting weapons to other countries.
  • Debit: Importing cars

Total Trade negative -> Deficit
Total Trade positive -> Surplus

Investment Income

Records the value of flows of income from investments in the form of interest, profit and dividends.

Examples:

  • Credit: Marks and Spencers having stores abroad and bringing profit back to the UK.
  • Debit: McDonalds having restaurants in the UK and then sending money back to the US.

Transfers

Records the transfers of money made and received by the government and individuals, e.g Remittances and payments to the IMF.

Examples:

  • Credit: Individuals sending money back to the UK from abroad.
  • Debit: Individuals sending money back to the Philiphines from the UK.

Problems with a Current Account Deficit

  • A C/A deficit means you have more imports than exports.
  • A C/A deficit is not usually considered as important as the other objectives.
  • AD = C + I + G + (X-M) so if net exports are falling, AD is shifting left.

This could cause a reduction in growth or recession, which also means higher unemployment.

Evaluation of C/A deficit

  • Inflation reduced / falling
  • ER will depreciate, which may cause an automatic correction
  • Other components of AD may be rising, which may mean overall there is growth.

Solving a C/A deficit

Expenditure Reducing

This method involves reducing the number of imports by generally reducing (luxury) consumption.

  • Increase IR (contractionary monetary)
  • Increase Income tax (contractionary fiscal)

However:

  • Decreases economic growth
  • Increases unemployment
  • The problem with a C/A deficit is reduced AD, but contractionary policy further reduces AD -> Government failure
  • Higher IR means borrowing more expensive
    • LICs affected more -> more inequality
  • Income taxes will impact LICs more

Expenditure Switching

Switching import consumption to domestic consumption.

  • Protectionism / Tariffs
    • May lead to retaliation
    • Distorts the market, second best option
  • Supply Side policies
    • Education and training
      • Opportunity cost and time lag
    • Deregulation
      • Risk to health and safety as well as environmental risks