1. 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

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

3. 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

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

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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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