BOP

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BOP

23 December 2019 BOP Current Account balance. -25,494

The BOP payments records all flows of money into and out of a country

Four Sections to Current ACCOUNT:

Trade in goods, Trade in Services, Investment and employment income(Primary INCOME), Transfers ( Secondary Income)

UK has large deficit on current account - every year single 1984

Large deficit on balance of visible trade, Small surplus on balance of invisible tad, surplus on flows of investment income, deficit on transfers

Causes of a BOP deficit:

High levels of consumer spending - when economic growth, consumers and firms buy more imports: income elasticity of demand for imports is high there will be greater increase in imports

Struggling to compete internationally-

-products too expensive so exports levels will reduce. Can occur with newly industrialised countries can produce goods much cheaper than developed countries

- countries may struggle to compete with other countries which have access to advanced technology. This is because this can lower the cost of production and improve products which are made.

-Structural problems such as labour immobility may make domestic goods and exports more expensive

If the value of the currency rises goods will become more expensive to foreign buyers, therefore will buy less exports

If Inflation rises exports will fall as they'll become more expensive and less competitive in foreign countries.

External Shocks

- rise in world price of imported raw materials, demand for these materials is price inelastic, country end up paying more for these imports

- economic downturn in a country to which a country exports could use sudden reduction in amount of exports demanded

- trade barriers on goods by another country could see a reduction in the number of exports made to the country

Current Account Surplus:

- Experiencing a recession- domestic producers may struggle to sell domestically so attempt to compete on international markets

- Domestic currency has a low value- exports cheaper/Imports more expensive

- High interest Rates causing more saving and less spending

Negatives of having a Current Account deficit:

Could suggest economy is uncompetitive

May lead to job losses domestically- more goods imported/ no need for domestic production- lead to unemployment

If current account deficit is financed through borrowing - unsustainable. Countries will not be carry on this borrowing in the long run and as a result will have to pay back money borrowed with high interest rates.

If countries finance their Current account deficit capital hot flows of money, can be dangerous as possibility investors could remove money and leads to devaluation and confidence crisis

If there is a current account deficit, need to have capital account/ financial account surplus meaning that foreigners have a claim on assets dn meaning they are financing the deficit.

Positives of having a Current Account deficit

Current account deficit could occur during a period of inward investment which could create jobs and investments. This could help stimulate growth in the economy - shown Japanese investment in UK where they also brought in new labour productivity methods

With a floating exchange rate, the current account deficit will likely cause a devaluation in the currency automatically decreasing the deficit.

Current Account deficit may just be an indication of a strong economy which is growing fast- rise ind deficit in primary incomes for UK in 2015-2016 shows investment in UK giving good returns to foreign investors.

Overall Effect of Current Account Deficit

Depends on the size of the deficit- deficit over 5% cause concern

How your financing the deficit- its fine if your financing it from long term capital investments

Depends on country- more dangerous for developing country as investors may quickly remove their money

2016- Current account deficit - 7% of GDP - caused by deficit in goods, deficit in primary incomes and deficit on transfers

Policies to reduce current account deficit:

Devaluation( Depreciation)

Devaluation of the currency will mean that price of importing goods increases and quantity demanded of imports decreases

Exports will become cheaper and there will be an increase in the demand for exports

Assuming demand is relatively price elastic, devaluation should lead to an improving in the current account deficit

Marshall Lerner Condition- devaluation will only improve the current account deficit on one condition which is the combined elasticity for imports and exports is over 1.

Short term- demand for exports and imports tends to be inelastic. Current account deficit gets worse before it gets better after devaluation. Over time , the demand becomes more price elastic improving the current account deficit. This is shown by the J curve.

Devaluation can lead to imported inflation. Imports will be more expensive. Inflation reduces country competitiveness. Improvements in current account may only by temporary.

Monetary Policy

Tight Monetary Policy

High interest rates- increase costs of debts and mortgage repayments- leave people with less money to spend- reduce their consumption of imports- improve current accounts

Higher Interest Rates- cause fall in Ad, reduce economic growth, which reduces inflation, which improve competitiveness of UK exports

Deflationary policy-put pressure on manufactures to reduce costs and will lead to more competitive exports - increase exports in long run

Problem of using monetary policy is that high interest rates tend to attract hot flows of money to a country. This will lead to an increase in the value of the exchange rate therefore make exports less competitive and imports cheaper. ( Based on Assumption demand is price elastic)

Overall effect is uncertain. It depends on which effect is bigger. As UK has a marginal propensity to import, high interest rates will cause a reduction in AD and therefore improve current account deficit.

Deflationary Fiscal Policy

Government could increase income tax which would reduce disposable income and therefore reduce spending on imports

Advantage of fiscal policy is it doesn't affect exchange rate and higher income tax improves government finances

Fiscal Policy will conflict with other macro-economic objectives-reducing in AD, economic growth will fall, unemployment levels rise.

Supply Side Policy

Government implement supply side policies to help remove structural problems. For example if the government undertook a policy of deregulation may help to improve efficiency as it would increase profit incentive. Increased efficiency help to produce lower costs, therefore make domestic products more competitive.

Take a considerable amount of time to actually have an effect

Protectionism

Government increase tariffs on imports or impose quotas which would decrease the deficit as imports being reduced

These type of measures can cause retaliation- other countries placing tariffs on our exports

Domestic industries may become uncompetitive as there is less incentive to cut costs as there is protection from the government implemented tariffs or quotas.

To Correct BOP surplus-might raise value of their currency . This will reduce demand for exports and increase demand for import. Likely lead to reduction in output and could cause rising unemployment.

Global Impacts of governments of major economies trying to correct imbalances:

Supply side polices to correct deficits may lead to increase in world trade and growth

Restriction on imports- trade wars reduce international trade and lower global efficiency

If governments attempt to reduce BOP deficit lead to fall in exports from developing countries- many negative consequences for developing countries.

Capital Account includes transfer of non-monetary and fixed assets. Includes the flow of immigrants and emigrants- when an immigrant arrives at UK total assets become part of UKs total assets.

Financial Account involves moving of financial assets. This includes:

Foreign Direct Investment

Portfolio Investment- investment in financial assets such as shares in oversea company

Financial derivatives- contracts whose value is based on value of an asset

Reserve Assets- financial assets held by bank of England to be used when needed

Current Account should balance capital and financial accounts. Often don't balance so balancing figure is needed

Long term flows due to things such as FDI and portfolio investment. Predictable usually as FDI occurs often when a country gains a comparative advantage in producing something, happens over long period of time.

Short Term flows- hot money- based on speculation and people trying to quickly make money- make profit through changes in exchange rates

International trade and capital flows- firms and governments have interests and investment in other countries

Causes economies to grow

Economies are now dependent on each other more than before- Banking crisis can spread and cause economic problems in many countries

One firm enters a recession- cause problems for countries it trades with

Global Trade Imbalances carry serious risk. Impose tariffs may cause retaliation with countries putting up own tariffs.

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