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Macroeconomics - balance of payments - The Balance of Payments is a record…
Macroeconomics - balance of payments - The Balance of Payments is a record of a country’s transactions with the rest of the world. It shows the receipts from trade. It consists of the current and financial account
current account
This is a record of all payments for trade in goods and services plus income flow it is divided into four parts.
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Balance of trade in services (invisibles) e.g. tourism, insurance.
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Net current transfers. Secondary income flows (e.g. government transfers to UN, EU)
financial account
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Direct investment. This is net investment from abroad. For example, if a UK firm built a factory in Japan it would be a debit item on UK financial account)
Portfolio investment. These are financial flows, such as the purchase of bonds, gilts or saving in banks. They include:
Short-term monetary flows known as “hot money flows” to take advantage of exchange rate changes, e.g. foreign investor saving money in a UK bank to take advantage of better interest rates – will be a credit item on financial account
balancing item
balance of payments equilibrium: a surplus in financial account is balanced by a deficit in the current account
In a floating exchange rate the supply of currency will always equal the demand for currency, and the balance of payments is zero.
Therefore if there is a deficit on the current account there will be a surplus on the financial/capital account.
If there was an increase in interest rates this would cause hot money flows to enter the UK, therefore there would be a surplus on the financial account
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