Macroeconomics: The balance of payments (Factors that cause a current…
Macroeconomics: The balance of payments
Balance of payments:
A record of a country's transactions with the rest of the world. It shows the receipts from trade and consists of the current account and financial/captial account.
Current Account: Is primarily concerned with the balance of trade in goods and services.
The components are:
Trade in goods, Trade in services, Net income flow and Net current transfers.
Current account = Financial + Capital account
Involves capital transfers or the acquisition of non-financial assets. It is relatively small compared to the other components.
Is a record of all transactions for financial investment. It includes financial flows and net investment.
Factors that cause a current account deficit:
2. Economic growth.
If there is an increase in real wages, people will have more disposable income to consume goods. If domestic producers cannot meet the domestic demand, consumers will import goods from abroad. Consumer-led growth often causes a deterioration in the UK current account.
1. Overvalued exchange rate.
If the currency is overvalued, imports will be cheaper and therefore there will be a higher quantity of imports.Exports will become uncompetitive and therefore there will be a fail in the quantity of exports
3. Inflation/ decline in competitiveness.
If there is relatively high inflation in the UK compared to our competitors, there will be less demand for UK exports because British consumers will prefer buying cheaper imports.
Current Account Deficit
Policies to reduce a deficit
This involves reducing the value of the currency against others, and making exports cheaper and exports more expensive. This should increase the quantity of exports and reduce imports.
2. Reduce consumer spending.
The government could pursue tight fiscal policy (higher tax to reduce consumer spending) or the BOE could increase interest rates. Lower Consumer spending will lead to less spending on imports, improving the current account
3. Suplpy-side policies.
These are policies aimed at increasing productivity and competitiveness. if successful, they will make UK exports more competitive and export demand will rise.
Effect of a current account deficit:
1. Lower AD
. A deficit represents a leakage from the economy. Money is being spent in other countries and, therefore, ceteris paribus, it reduces UK AD
On the other hand, a current account deficit may occur due to high level of consumer spending and economic growth. deficit is often smaller in a recession.
A current account deficit could cause a depreciation in the value of the exchange rate, because we are buying imports and, therefore, buying foreign currency.
A current account deficit occurs when the value of imports is greater than the value of exports
Current Account Surplus
Potential problems of a large current account surplus:
If one country runs a large current account surplus, it means other countries will have a similar deficit.
In the eurozone, current account imbalances are more of a problem because countries can't rely on a depreciation to solve the imbalance.
It represents an unbalanced economy - dominated by exports and showing low levels of consumer spending
Can reduce a current account surplus by:
Allowing the exchange rate to appreciate, reducing competitiveness
Encouraging consumer spending, leading to higher import spending.
A current account surplus occurs when the value of imports is less then exports.