The Balance of PaymentsDefinition and structure

Balance of payments

• overall view of transactions with the rest of the world.

• Made up of three separate accounts

• Current Account• Capital Account• Financial Account

Balance of Payments – Current Account• It is a record of all money flows from

international transactions between the Kz and the rest of the world

•Trade in Goods•Trade in Services• Investment Income•Capital Transfers

Trade in Goods (visibles)

•Consumer Durables•Capital Goods•Commodities•Components•Foodstuffs and Beverages

Services (invisibles)

•Tourism•Financial Services•Insurance•Music and entertainment•Banking

Financial Account: Investment Income•Investment in companies overseas,•And their investment in us•FDI Foreign Direct Investment.•Other investments e.g. Loans to banks.

Capital Transfers

•Transfer of money between individuals•Kazakhs working overseas•Grants to overseas countries•Contributions to International

organisations e.g. IMF, World Bank and WTO.

Capital Account

•Acquisition or disposal of Non produced or non financial assets.

•Capital transfer credits•Donation from Canada to Tanzania for

schools•Dr from Canada Cr to Tanzania•Capital transfer debits•UK to finance an Airport St. Helena.

Debt forgiveness

•If Rwanda relieved of its debts = Cr in Rwanda’s capital account.

•If a bank in Switzerland , which made a loan to government of Sierra Leone waived that debt = Dr in Switzerland’s Capital Account.

Foreign Exchange Reserves

•If there is a deficit in the Balance of Payments the government will draw on reserves to rectify the deficit and support the exchange rate.

Current Account

Prepare the balance of payments for the country whose international exchanges are shown in the table below

CategoryBalance/billions $

Imports of goods 550Import of services 400export of goods 380export of services 550income -130current transfers 70direct investment 40portfolio investment -80capital transfers 90transactions in non produced non financial assets -25reserve assets a. balance of payments b.

Prepare the balance of payments for the country whose international exchanges are shown in the table below

CategoryBalance/billions $

Imports of goods 550 CAImport of services 400 CAexport of goods 380 CAexport of services 550 CAincome -130 CAcurrent transfers 70 CAdirect investment 40 FAportfolio investment -80 FAcapital transfers 90 Cap Actransactions in non produced non financial assets -25 Cap Acreserve assets a. balance of payments b.

Calculate the following balances

i current account -80

ii financial account -40

iii capital account 65

iv reserve assets 55

v balance of payments 0

UK Deficit Narrows

of which: EU  £3.2    non-EU  -£10.9

Trade in Goods Deficit Widens

Prepare the balance of payments for the country whose international exchanges are shown in the table below

CategoryBalance/billions $

Imports of goods 550Import of services 400export of goods 380export of services 550income -130current transfers 70direct investment 40portfolio investment -80capital transfers 90transactions in non produced non financial assets -25reserve assets a. balance of payments b.

Consequences for Japan Balance of Payments Surplus•Positive Current Account balance.

•Country has a high demand for exports•High demand for local currency•Leads to appreciation of currency value•Makes M cheaper

Consequences for USA of a Balance of Payments Deficit•Negative Current Account Balance

•Means that another part of the account must be in surplus to create a balance of money.

•The magnitude of the deficit is important, measured as a % of GDP

How to fix a large Current Account Deficit •Encouraging

people to buy locally produced products.

•Devalue currency

•Reduce AD.

Demand & Supply side causes of deficit

•Short-term factors eg Strong consumer demand –

•Leads to a very high level of demand for imported goods and services

•UK consumers have a high income elasticity of demand for overseas-produced goods

Demand & Supply side causes of deficit

•The strong sterling exchange rate in the past has helped to reduce the UK price of imports causing expenditure-switching effect

•weakness of the global economy and in particular the very slow growth in the Euro Zone has damaged UK export growth.

causes of deficit in UK

• 55% of all UK X go to EU

• shifts in comparative advantage (China)

• The availability of cheaper M inevitably causes a substitution effect from British consumers

Causes of deficit

• Weak product innovation and R & D• The UK manufacturing sector has been in long-

term decline for more than twenty years. • Lack of productivity, inflexible labour market

Implications of a deficit• There is a net outflow of demand and income from the

circular flow of income and spending. • The current account need not balance as long as the

financial account is in surplus – need to attract investment, savings etc

• The UK has run large current account deficits in with barely any effect on the overall economy.

• Small chance of speculative selling of sterling on the foreign exchange markets

Implications of a deficit• If the deficit is due to very strong consumer

demand, it automatically self corrects when the economic cycle turns

• increased imports of new capital & technology which improves productivity in LR could cause deficit – not a problem

•A widening trade deficit may result in lost output & employment because it represents a net leakage.

Implications of a deficit

•Foreign investors may eventually take fright, lose confidence and take their money out.

•Deficit represents an S>D of the currency in the foreign exchange market

• can lead to a Price therefore exchange rate

WILL A DEPRECIATION OF THE CURRENCY LEAD TO THE ELIMINATION OF A BALANCE OF TRADE

DEFICIT?

Surplus on the current account

Deficit on the current account

Time

Point when currency depreciates

Net improvemen

t

terms of trade

•= the rate of exchange of one good or service for another when two countries trade with each other. 

Terms of Trade Index  

•ToT = 100 x Average export price index / Average import price index

•If export prices  faster than M prices, . • D X and D M •If import prices  faster than export

prices, the terms of trade have deteriorated

Plenary

•On your boards write two important things you have learned about the Balance of Payments.