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Balance of Payments
Transcript of Balance of Payments
Does a country benefit from International Trade?
Definition: A record of the value of all the transactions between the residents of one country with the residents of all other countries in the world over a given period of time.
In a nutshell: value of imports vs. exports
2 Major Parts
The Financial Account
balance of trade in goods
balance of trade in services (invisible balance)
inflows (bring money into a country)
outflows (send money out of a country)
foreign workers (like me - sort of)
Items with (enduring) value
(implied) ownership vs. lending
stocks (etc), bonds, FDI, bank accounts, currency
Ensures that the balance is always zero!
net income flows
Using the correct terminology and actual numbers, describe Panama's balance of payments position, as shown by the data. Consider each of the components of the b.o.p. (in bold), using real numbers to explain whether each is a surplus or deficit. Explain how the balance of payments as a whole is balanced.
Consequences of surpluses and deficits
Current account deficit
If the current account is in deficit, then the financial account will have to be in surplus. This means one of three things.
1. Foreign exchange Reserves may have to be used to increase the capital account, but this cannot go on forever.
2. A high level of foreigners buying domestic assets may be financing the current account deficit.
3. A high level of borrowing, with high interest repayments, may be financing the current account deficit.
Current account surplus
Exchange Rates: See Below
Correcting Current Account Deficits
definition: motivate consumers to spend money on domestic rather than imported goods and services
Depreciation of currency
Elastic vs. Inelastic goods
PED (exports) + PED (imports) > 1
Review/Apply PED (for imports & exports)
Illustrate using revenue boxes
appreciate/depreciate + import/exports
reduce / restrict imports
threat of rebuttal
Shift overall demand to the left
reduces demand of exports (and everything else)
Monetary and Fiscal Policy -
What you need to know!
define and explain: the BOP account, current account (incl elements), capital account (incl elements), consequences of current account & capital account imbalances, examples of expenditure policies
HL - marshall-lerner condition, the J-Curve
A measure of the flow of funds from trade in goods and services, plus other income flows.
(visible balance): A measure of the revenue received from the export of tangible (physical) goods minus the expenditure on the imports of tangible goods over a given period of time.
A measure of the revenue received from the export of tangible services minus the expenditure on the imports of services over a given period of time.
Net investment income plus net transfers of money.
A measure of the net monetary movement of profit, interest and dividends moving in and out of a country over a given period of time as a result of financial investment abroad.
Payments made between countries where no goods or services change hands, e.g. government foreign aid and foreign workers sending money back to their home country.
Current Account balance = balance of trade in goods + balance of trade in services + net income flows
A measure of the buying and selling of assets between countries. It measures the net change in foreign ownership of domestic assets.
Foreign direct investment (FDI; investment by multinational corporations in another country)
portfolio investment (investment in stocks and shares)
other investment (currency transactions and bank and savings account deposits).
A deficit of the Capital Account. One country's surplus is anothers deficit.
The surplus usually leads to an appreciation of the currency, which makes imports cheaper, reducing inflation, but exports more expensive, leading to unemployment.
The country with a Current Account surplus can build up foreign reserves or buy assets abroad.
A financial account surplus may have two consequences.
1. If it is based upon the purchasing of assets for ownership, it is usually a positive thing and allows a current account deficit.
2. If it is based upon high levels of borrowing from abroad, it is usually a bad thing in
Deflationary Fiscal policy
Increase direct taxes
reduce govt expenditure
Deflationary monetary policy
Increase interest rates
higher interest rates will increase capital flows
Capital Account surplus
increased cost to loan money is unpopular
reduce the Current Accoutn deficit
reduce the rate of economic growth
reduce employment domestically
reduced domestic investment
unpopular at home!
The Marshall-Lerner Condition
Surely a depreciated currency means more expensive imports and cheaper exports?!
What about elasticity of demand for these goods?
A relative fall in the export prices depends of the price elasticity of foreign countries!
What happens if they still don't demand that much more relative to the fall in demand?
The same applies for imports!
The Marshall Condition tells us how successful a depreciation or devaluation of a currency's exchange rate will be as a means to improve a current account deficit in the BOP.
only successful IF the total value of the price elasticity or demands for exports and the price elasticity of demand for imports is great than one.
PED exports + PED imports > 1
elastic Exports = quantity demanded will increase =
more revenue for the country
Elastic Imports = lower quantity demanded = reduced expenditure on imports
Improved BOP position
The J -Curve
A country reduces the exchange rate of it's country to limit the deficit on the Current Account
In the Short-Run this may not mean an improvement!
in the SHORT-RUN emports are inelastic = lower revenue realisations
In the SHORT-RUN imports are inelastic
Form a group of four.
Explain to the class how the Exchange Rates are connected to the BOP.
- Student Workpoint 24.2 p299
- Q2 p 307
Currrent Acct Surplus - Green
Current Account Deficit - Brown
Exchange rates & BOP