Balance of Payments “A useful way to think about the balance of payments is that it is an account that records purchases and sales of sterling by those making international transactions. Purchases of sterling are recorded as positive items, sales as negative ones. Since it is not possible for someone to buy a pound without someone else selling them one, the balance of payments must add up to zero.” - Philip Allan Updates, Unit 6 Student Unit Guide, pg. 34

Current Account Net trade in goods Net trade in services Net income flows (interest on foreign bank acc’ts, dividends on shares held in foreign companies, income from FDI) Net current transfers – payment from one gov’t to another (development aid, EU subscription payments)

Financial Account Financial flows – investment from one country to another, purchasing of foreign shares/bonds, FDI Money saved in banks overseas Official changes in gov’t foreign exch. reserves  Should offset the current acc’t balance!

B of P Disequilibrium (a structural current account deficit) For the UK the persistent trade deficit has short and long term causes: high propensity to buy imported goods / services –UK consumers prefer foreign produced output – this is cyclical (a consumer boom often accelerates imports) lack of productive capacity of UK firms - if domestic producers have insufficient capacity to meet domestic demand then imports will make up the balance ↓ comparative advantage - UK manufacturing has suffered from low-cost production in newly Industrialising countries in other parts of Europe (net x: capital gds, chemicals; net m: food, cars, aircraft, consumer gds)

B of P Disequilibrium cont’ poor price and non-price competitiveness of UK firms - cost levels decrease competitiveness, but non-price factors are also important – eg. quality, design, reliability and service over valued exchange rate? - some economists think trade problems stem from the exch. rate being too high ↓ surplus in UK's trade in oil - UK used to be a major exporter of oil from the North Sea – oil production is now well past its peak and net surplus from oil trade no longer contribute as much to the balance of visible trade current transfers generally negative – UK is net contributor to EU budget – gives more in membership subscriptions than it gets in agr. subsidies & inner city development

Positive Trends for UK Current Acc’t Income acc’t is positive – UK multinational investment in 1990’s is now returning income flows to the UK Services acc’t is positive – esp. financial, insurance, advertising, computer services (but travel services are negative)

Correcting BofP Disequilibrium In order to need ‘correcting’, current account deficit must be structural rather than cyclical Structural deficit could be sustainable with a surplus on the financial account but it requires “hot money” which is very vulnerable to speculation & sentiment

Correcting BofP Disequilibrium Exchange Rate Adjustment: depreciation to raise international competitiveness (not a policy tool in the UK!) Achieved by cuts in interest rates or increase in foreign currency reserves But, this is a ‘loosening’ monetary policy which could cause inflation Also, rapid outflow of ‘hot money’ could threaten funding for current acc’t deficit

Correcting BofP Disequilibrium Demand Management: reducing AD by tightening fiscal or monetary policy -  disposable income →  imports Dependent on YED of imports Will also  output &  unemployment

Correcting BofP Disequilibrium Supply-Side Policies: raise labour productivity; make UK more competitive – may also focus on quality of production May reduce working conditions & rights of workers Tend to have long-term effect but limited in the short-run