Microeconomics Topic 1: The Economic Problem 2.1.4 Unit content Students should be able to: Define balance of payments and the key components (the current account, and the balance of trade in goods and services) Analyse current account deficits and surpluses Assess the causes and costs of an imbalance in the current account Analyse the relationship between current account imbalances and other macroeconomic objectives Evaluate the interconnectedness of economies through international trade

International competitiveness Most economies are involved in trading with other countries and are involved in exporting (selling goods or services to a foreign country which generates income for the home country) and importing (buying goods from abroad which leads to expenditure for the home country) So they need to be competitive in order that overseas customers will buy. This will depend on inflation as well as productivity.

Microeconomics Topic 1: The Economic Problem Balance of payments The balance of payments (BOP) records all financial transactions made between consumers, businesses and the government in one country with other countries. It can be split into two parts: ‘Current account’ and the ‘Capital and financial accounts’. For the syllabus we just look at the current account.

Microeconomics Topic 1: The Economic Problem Current account The current account records payments for the purchase and sale of g______ and s_________, investment income and transfers. The capital and financial accounts record the flow of finance between the UK and other countries e.g. money associated with saving, investment, and currency dealings. For the syllabus we just look at the current account.

The two parts of the current account The current account is split into: Visibles – imports and exports of _______ Invisibles – imports and export of _________ and investment income Visible exports result in goods leaving the UK and money entering the UK. This is shown as a ____________ on the balance of payments account.

The United Kingdom mainly exports: What are the main exports for the UK? Who are our main export partners? The United Kingdom mainly exports: Main export partners are:

Visible imports and the balance of trade Why are visible imports shown as a negative? Because If I go on holiday abroad then this is recorded as an import because What does the UK import? The difference between visible exports and visible imports is known as the balance of trade

How would a French firm sending profits back to France be classified? Invisible examples How would a British worker in France sending money back to the UK be classified? How would a French firm sending profits back to France be classified?

The balance on invisible trade and the current balance The balance on invisible trade or net invisibles is the difference between invisible ________ and invisible ________ The current balance is the difference between total _______ (visible and invisible) and total imports

More details on the current account The current account consists of four items: Trade in goods Trade in services Investment income: interest, profit and dividends from investments abroad. It does NOT include the flow of investment funds. Transfers: tax payments to foreign governments, payments to British military personnel abroad, money migrants send home

Current account deficits How can a household have a deficit? How will it manage? Similarly the British economy can have a current account deficit if it ______ more than it _______ In this case it must ______ money from overseas. It will have to run a surplus on its capital account.

What causes a current account deficit? The c___________ is too strong relative to other countries. E.g. if £1 was $1 but then £1 = $2 then High rates of i_______ relative to other countries High w_______ costs relative to other countries High level of g__________ in a country, as people with higher incomes tend to buy more imports from abroad

This is caused largely by the: UK Current account The UK has had a persistent current account __________ in the past 15 years. This is caused largely by the: In Q2 2015, the UK’s current account ______ was £_____ billion (3.6% of GDP) This is lower than previous current account deficit of 5.2% in Q1 2015.

Current account surplus How can a household have a surplus? How can the economy have a current account surplus? In this case it will run a deficit on its capital and financial account.

Summary of current account surpluses Remember a current account surplus on the balance of payments occurs when more money is flowing into the country than is flowing out. A country such as _______, which exports a large number of high-value goods, has a surplus on the current account, meaning that more money flows in than flows out. A country with a high standard of living but which is less successful in exports may run a deficit e.g.

What causes a current account surplus?

Are current account deficits ‘good’ or ‘bad’? A current account deficit may be a sign of poor economic management or economic weakness. However, if the deficit is small in relation to the size of the economy then it is of little economic significance. Similarly if an economy has a large current account deficit but then has a large current account surplus the following year, then this is not really a problem. A current account deficit only matters if __________ _________________________________________

Large, sustained current account deficits A large and sustained current account deficit is unsustainable in the long run as foreign lenders will eventually think that the country will be unable to pay its debts. Lenders will then _______ lending. This happened to Brazil in the 1980s and Thailand in the 1990s

How can a country reduce its current account deficit? It needs to _______ more and/or ________ less. The local population will have Increasing interest rates and/or increasing taxes will ______ domestic consumption. This will _________ inflation (lowers demand pull inflation) and make local goods and services __________ to buy abroad.

When might a large, sustained current account deficit be beneficial? When the economy is growing at a faster rate. E.g. if an economy is growing at 10% a year and its current account deficit is 4% then the country will be able to pay since the debt is ___________ slowly than the economy. However if its economy was growing at 1% then it will have problems.

Large, sustained current account surplus If an economy has a large, sustained current account surplus it is __________ more than it is _______________ This means that their net foreign wealth is increasing. This money may be used at a later date, rather as a household may save now for later. E.g. J______ has a current account surplus but this will be needed to pay for its _______ population.

Drawbacks of a large, sustained current account surplus

WARNING: Budget deficit When the government is running a budget deficit, it means that in a given year, total government expenditure exceeds total tax revenue. In your textbook they refer to this as the PSNCR = public sector net cash requirement. Note that this is NOT the same as a current account deficit since the current account deficit is created by firms and individuals (as well as the government)

Current account and interest rates We look at this in more detail later. Briefly, when the interest rate rises in the UK, the exchange rate usually does too (e.g. £1 = $1 then £1 = $2). This means that __________ become more competitive (cheaper) and _________ become less competitive (more expensive). Hence the current account deficit will worsen