2.1.4 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 & 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

• 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
    
    

• 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
      
      

• 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 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