The Balance of Payments Learning outcome AF Describe the main components of the UK balance of payments Explain the pattern of the UK balance of payments in recent years Evaluate the importance of current account deficits and surpluses Explain policies to reduce a long run current account deficit Reading: Unit 30

Balance of Payments Record of all financial transactions that take place between agents in one country and all other countries

Balance of Payments The balance of payments can be split into two parts: Capital account Current account Flows of money into the country are calculated as positive Flows of money out of the country are calculated as negative The balance of payments measures the inward flow minus the outward flow of money The balance of payments can therefore be positive or negative

Flows of capital (money) between countries Capital account Flows of capital (money) between countries

Flows of payments for goods and services between countries Current account Flows of payments for goods and services between countries

Current account The current account can be split again into: Visibles (trade in goods) The export of goods leads to money flowing in (positive) The import of goods leads to money flowing out (negative) The difference between the two is balance of trade Invisibles (trade in services) The export of services leads to money flowing in (positive) The import of services leads to money flowing out (negative) The difference between the two is the balance on invisible trade

Current account The current account balance shows the difference between money flowing in and money flowing out If inward flow is greater than outward flow there is a current account surplus If outward flow is greater than inward flow there is a current account deficit

Current account surplus A surplus is seen as a good thing as there will be an increase in the countries’ net foreign wealth This net foreign wealth can be used in the future when it is needed A surplus however will reduce what is available for consumption now A long-term surplus may cause political problems between countries

Current account deficit A deficit is seen as a bad thing as the deficit has to be financed Foreign organisations will provide finance until they think the debt is too large to be sustained If they stop lending then the country will be in serious trouble (sometimes called a credit crunch) The problem of a large current account deficit can be solved through economic growth, if GDP is growing faster than the foreign debt then debt will fall as a % of GDP

Policies to reduce a long-run current account deficit Devaluation If the value of the currency is decreased then exports will be relatively cheaper and imports relatively more expensive Exports (X) will increase Imports (M) will decrease The current account deficit will therefore get smaller This is sometimes referred to as the Marshall-Lerner condition

Policies to reduce a long-run current account deficit Deflation Deflation (or relatively lower inflation) will reduce prices relative to other countries, this makes exports relatively cheaper and imports relatively more expensive Exports (X) will increase Imports (M) will decrease The current account deficit will therefore get smaller

Policies to reduce a long-run current account deficit Import controls Government can reduce imports by introducing trade barriers (see previous lecture) i.e. tariffs, quotas etc. The use of trade barriers may however lead to retaliation from other countries