L26 - The Balance of Payments and Exchange Rates - Part 2 Flashcards Preview

18ECA001 - Principles of Macroeconomics > L26 - The Balance of Payments and Exchange Rates - Part 2 > Flashcards

Flashcards in L26 - The Balance of Payments and Exchange Rates - Part 2 Deck (14)
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1
Q

What is the Balance of Payments?

A
  • In order to know what is happening to international payments, governments keep track of the transactions between countries.
  • The balance-of-payments accounts records these transactions .
  • Current account –> records international flows of goods, services, income of domestic residents and transfer payments ( workers send money to foreign countries).
  • Capital and Financial account –> records transactions related to international movements of ownership of financial assets.
2
Q

What is the Current Account broken up into?

A
  • Visible Account –> also the good and service, trade or merchandise account -records payments and receipts arising from import (debit) and exports (credit) of tangible goods and other services
  • Income Account –>
    1. employee compensation (credit items involve UK workers being paid by non UK residents while debit items result from UK business employing non-UK residents)
    2. investment income ( Credit items involve interest and dividend income received by UK residents from assets overseas, while debits reflect similar payments to non-residents owners pf assets in the UK)
  • Current Transfers–> This is Subdivided into central government (e.g. payment to a pensioner who lives in Spain) and other transfers (sending money to a family member in another country(
  • All components of the current account other than trade in goods are sometimes referred to as invisibles
3
Q

What is the Capital and Financial Account broken up into?

A
  • Capital Account –> anything related to cross- border movements in ownership of assets, a large part of which involves financial instruments such as ownership of company shares, bank loans or government securities ( in the book its broken up into Capital Transfers and Acquisition/disposal of non-produced, non-financial assets)

Financial Account–>
1 - Direct Investment - relates to changes in non-resident ownership of domestic firms and resident ownership of foreign firms two forms of this is called greenfield and brownfield investment
2 - Portfolio Investment - investment in bonds or a minority holding of shares that does not involve legal control
( Direct and Portfolio Investments are sometimes combined as Long-term capital elements in the Balance of payments)
3 - Other Investment - mainly make up what is called short-term capital flow e.g .deposits and loans intermediated by UK-based banks, sale and purchases of short-term financial instruments such as Treasury Bills or Commercial bills
4 - Reserve Assets - reflect changes in the official foreign exchange reserves that are held by the Bank of England

4
Q

What is Greenfield Investment?

A

green field investment is a type of foreign direct investment (FDI) where a parent company builds its operations in a foreign country from the ground up. In addition to the construction of new production facilities, these projects can also include the building of new distribution hubs, offices and living quarters

5
Q

What is Brownfield Investment?

A

Brown field investment (sometimes hyphenated) is when a company or government entity purchases or leases existing production facilities to launch a new production activity.

6
Q

How should the current and capital accounts be related?

A
  • The current and capital account balances are necessarily of equal and opposite size - when added together they equal zero
  • However in practice the national income statisticians are not able to keep totally accurate records of all transactions and hence there is always error in measurement
  • this means that a balancing item, called net errors and omission is included in the balance of payments table
  • This balancing items stands for all unrecorded transactions and is defined to be equal to the difference between the measured current account and the measure capital and financial account
7
Q

What do the term surplus and deficit refer to in the Balance of Payments?

A
  • the terms balance of payment deficit/surplus must refer to the balance on some part of the payments account in the UK these terms almost always apply to the current account
  • A balance on the current account must be matched by a balance on the capital and financial accounts of equal magnitude but opposite sign.
  • There is nothing inherently good or bad about surpluses or deficits on the current account.
  • Persistent deficits or surpluses, involve a build up or run-down of a country’s net foreign assets.
  • The existence of a current account balance of payments deficit tells us only that an economy’s total spending on current account items exceeds its total receipts on that account and that it has a capital inflow.
  • The existence of such as deficit is consistent both with both productive borrowing by healthy growing economies and with unproductive borrowing to finance spending that does not add to future productive capacity
8
Q

What is Mercantilism?

A

Mercantilism was an economic system of trade that spanned from the 16th century to the 18th century. Mercantilism banked on the principle that the world’s wealth was static, consequently, many European nations attempted to accumulate the largest possible share of that wealth by maximizing their exports and by limiting their imports via tariffs

9
Q

What are Actual and Desired Transaction?

A
  • Actual –> is the actual capital inflow that must equal the actual current account deficit
  • desired –> current account transactions should equal desired capital account transactions
  • movement in the exchange rates play a key role in reconciling actual and desired transactions (at least for a country that has its own currency and flexible exchange rate)
  • This is the same as in any markets what is bought must must be equal to what is sold
  • which is what the balance of payments statistics record
  • But what people want to buy may not equal what others want to sell, which is what demand and supply curve tells us
  • When these two desires are not equal the price - in this case the exchange rate - changes until these two are bought
10
Q

What is the most common reason why a balance of payment crisis occur?

A
  • The most common reason for balance of payments crises is that investors in a specific economy revise their analysis of an economy’s prospects and come to believe that the level of international borrowing is unsustainable.
  • At this point, capital inflows turn into outflows as foreigners try to get their money out and also domestic residents try to move their funds abroad.
  • If the exchange rate is pegged by the domestic government, there will be a run on official foreign-exchange reserves and this will put pressure on the domestic authorities to change their monetary and/or fiscal policies.
    0 If the currency is floating, the exchange rate will fall sharply and this will lead to a sharp increase in domestic inflation.
  • The existence of a current account balance of payments deficit tells us only that an economy’s total spending exceeds its total income and that it has a capital inflow.
  • The causes differ from place to place and time to time.
11
Q

What are some reasons why change in an assessment of a economy can trigger a crisis?

A
  • There could be many reasons for the change in assessment of an
    economy that triggers a crisis.
  • It could be political instability or the introduction of profligate government spending plans.
  • It could be a sharp fall in market price of the country’s main export commodity.
  • It could be a general rise in world interest rates that sharply increases the costs of servicing foreign debts.
  • Countries hit by such crises generally seek loans from the International Monetary Fund (IMF).
  • As a condition of the loan the IMF usually requires a significant tightening of domestic monetary and fiscal policies,such as higher interest rates, cuts in spending, and higher taxes.
12
Q

What is the role of the IMF?

A
  • Provision of foreign currencies (via quotas)
  • Provision of world liquidity
  • The SDR –> an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserve
  • IMF Stabilisation Programme includes:
  • Fiscal contraction
  • Monetary contraction
  • Devaluation of exchange rate
  • Liberalisation of economy
13
Q

Who were two main suffers of the BP crises?

A
  • Two main groups suffer from the after-effects of BP crises.
  • International banks and other investors who have lent to the country may find that the value of their investment has fallen
    sharply or in some cases that there is a debt default.
  • The main sufferers, however, are domestic residents who often
    suffer sharp falls in their income and wealth and may lose their jobs or their businesses.
  • Critics of IMF policies have argued that the IMF loans and the conditions attached help to bailout international investors but do little to help the adjustment pains felt by domestic residents.
  • This is controversial, but it seems unlikely that countries
    suffering such crises could be better off with no source of international financial support even if it is conceded that the
    handling of such crises by the IMF could be improved
14
Q

What are specific criticisms of the IMF stabilisation programme?

A
  • IMF programmes inappropriate
  • IMF programmes inflexible
  • IMF support inadequate and too expensive
  • IMF dominated by major industrial countries.