Balance of Payments (Edexcel A Level Economics A)
Revision Note
Components of the Balance of Payments
The Balance of Payments (BoP) for a country is a record of all the financial transactions that occur between it and the rest of the world
The BoP has two main sections:
The current account: all transactions related to goods/services along with payments related to the transfer of income
The financial and capital account: all transactions related to savings, investment and currency stabilisation
It is called the BoP as the current account should balance with the capital/financial account and be equal to zero
If the current account balance is positive, then the capital/financial account balance is negative (and vice versa)
Money flowing into the country is recorded in the relevant account as a credit (+) and money flowing out as a debit (-)
The current account of the balance of payments
The Current Account is often considered to be the most important account in the BoP
It records the net income that an economy gains from international transactions
An Example of the UK Current Account Balance For 2017
Component | 2017 |
---|---|
Net trade in goods (exports - imports) | £-32.9bn |
Net trade in services (exports - imports) | £27.9bn |
Sub-total trade in goods/services | £-5bn |
Net income (interest, profits and dividends) | £-2.1bn |
Current transfers | £-3.6bn |
Total Current Account Balance | £-10.7bn |
Current Account as a % of GDP | 3.7% |
Goods are also referred to as visible exports/imports
Services are also referred to as invisible exports/imports
Net income consists of income transfers by citizens and corporations
Credits are received from UK citizens who are abroad and send remittances home
Debits are sent by foreigners working in the UK back to their countries
Current transfers are typically payments at government level between countries e.g. contributions to the World Bank
The Current Account balance is often expressed as a % of GDP
This allows for easy international comparisons
Current Account Deficits and Surpluses
A Current Account deficit occurs when the value of the outflows is greater than the value of the inflows
Usually occurs when the imports > exports
A Current Account surplus occurs when the value of the inflows is greater than the value of the outflows
Usually occurs when imports < exports
The UK government has a macroeconomic aim to get their Current Account balance as close to equilibrium as possible
Most years it tends to run a small deficit
Export led economic growth would help it become positive
However, with increasing income and wealth in an economy, the value of imports rises
Consumers enjoy the variety of goods/services abroad
Rising imports push the balance towards a deficit
Examiner Tip
Students sometimes confuse a UK Government Budget deficit with a Current Account deficit. Ensure that your understanding of the distinction between these two concepts is clear.
The Budget deficit occurs when: UK Government spending > UK Government revenue (tax receipts).
The Current Account deficit refers to the BOP.
The Relationship Between the Current Account Imbalances & Macroeconomic Objectives
The UK government has a range of macroeconomic objectives which they attempt to achieve
Setting policies to target one objective may complicate the possibility of achieving other objectives
There is a trade-off
If the Current Account is running a deficit, this has a negative impact on aggregate demand (AD)
Net exports are a component of AD
If net exports are negative then AD decreases
To correct the current account deficit, the government could raise tariffs
This would likely decrease imports bought by households
Firms who rely on imports for raw materials used in production, would now face higher costs of production
These higher costs are likely to be passed on to consumers in the form of higher prices
Reducing the current account deficit has come at the expense of increased inflation in the economy - there has been a trade-off
The Interconnectedness of Economies Through Trade
The world is more connected than ever and there is a high level of interdependence between economies
Covid 19 and the Ukraine War demonstrated how disruptions in one part of the world cause widespread problems in others
One country's imports are another country's exports
Theoretically, the global value of exports will be equal to the global value of imports
Producers all over the world are often highly dependent on imported raw materials used in production e.g. a motor car has around 30,000 individual parts
Building a car is a global effort and requires a high level of interconnectedness between multiple economies
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