Unit 4.6 - Balance of Payments

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A situation exists when the total value of credit items exceeds the total value of debit items, over a given period of time.

Surplus on an account

A situation exists when the total value of debit items exceeds the total value of credit items, over a given period of time.

Deficit on an account

Any money entering an economy is referred to as this.

Inflow / credit

Payments made to external consumers, firms, institutions, or governments.

debit items

Payments received from external consumers, firms, institutions, or governments.

credit items

The monetary exit from an economy that occurs through payments for imports or international transfers, reflecting a decrease in domestic financial resources.

Outflow / debit

BOP

A financial document that records all transactions between a country and the rest of the world during a set period, often a year. It captures exports and imports, investments, and money flows, which are pivotal in assessing the country’s economic health and international financial relations.

Credit

An inflow of money entering an economy, recorded as credit items on the balance of payments. This includes payments received from consumers, firms, and governments located outside the economy, such as export sales.

Debit

An outflow of money leaving an economy, recorded as debit items on the balance of payments. This includes payments made to consumers, firms, and governments located outside the economy, such as import expenditures.

Deficit

A situation where the total value of debit items exceeds the total value of credit items on the balance of payments, indicating a negative balance similar to being in debt.

Inflow

Any money entering an economy, which is considered a credit to the country’s balance of payments. Inflows can come from various sources, such as exports and foreign investments.

Outflow

Any money leaving an economy, which is recorded as a debit on the balance of payments. Outflows can include payments for imports and income transfers to other countries.

Repatriation of profits

The process of returning profits earned by multinational companies back to their home country, recorded as a debit item on the balance of payments, representing an outflow of money.

income transfers

Payments made across borders involving the transfer of income, such as remittances and pensions. These transactions are part of the current account in the balance of payments and reflect financial flows that influence economic relationships between nations.

The difference between the value of exported goods and services and imported goods and services.

trade balance

The inflows and outflows of money that occur without a corresponding exchange for goods or services.

Current Transfers

The overall total of transactions recorded in the current section.

current account balance

The record of what a country earns from selling intangibles such as banking, tourism and insurance abroad, set against what it pays for them.

balance of trade in services

The record of what a country earns from selling physical products abroad, set against what it pays for those it buys in.

balance of trade in goods

State the formula: Current account balance

Current account balance = Sum of net exports of goods and services + Net income + Net current transfers Gives the overall current account balance by summing the three component net positions.

State the formula: Net current transfers

Net current transfers = Current transfers from abroad - Current transfers sent abroad Calculates net flows of transfers such as aid, grants and remittances.

State the formula: Net exports of goods and services

Net exports of goods and services = Exports of goods and services - Imports of goods and services Net exports of goods and services = Balance of trade in goods and services = (X − M)

State the formula: Net income from abroad

Net income from abroad = Income from abroad - Income paid abroad Measures the net receipts of factor income from foreign sources after payments to foreign investors.

J-curveHL

An economic model illustrating that a country's balance of trade initially worsens following a currency depreciation before it improves. This occurs due to time lags in consumer and firm responses to changes in relative prices.

contractionary demand-side policiesHL

Policies that aim to reduce inflation and aggregate demand, often through higher interest rates or taxes. These measures can impact economic growth and employment levels, particularly during times of economic expansion.

expenditure switchingHL

Policies aimed at encouraging consumers to switch their spending from imported goods to domestically produced goods. However, their effectiveness can be limited by non-price factors like quality and brand loyalty.

freely floating exchange rateHL

A system where the exchange rate is determined by market forces without direct government or central bank intervention. This allows for equilibrium in the long run, balancing debits and credits in the balance of payments, as demand and supply of currencies adjust freely.

A fall in the value of currency, fixed or floating.HL

Devaluation / depreciation

Policies aimed at redirecting spending from imports to domestic goods.HL

Expenditure-switching policies

Strategies designed to diminish total spending in an economy, thereby limiting consumption of domestic and imported goods to help correct trade deficits.HL

Expenditure-reducing policies

FDIHL

Foreign Direct Investment, which involves investments made by a company or individual in one country in business interests in another country. It typically requires the investor to demand the domestic currency, impacting its value positively.

currency depreciationHL

The reduction in the value of a currency in relation to others, often resulting from increased supply of that currency in the market. This can occur when domestic investors pay dividends in foreign currencies, leading to an excess supply of the local currency.

A record of transactions that relate to the change in ownership of assets, that is, cross-border investments.HL

financial account

A situation in which the total value of credits equals the total value of debits in an economy, resulting in no net surplus or deficit in external transactions.HL

Balanced current account

A situation where, over a given period, a country's export earnings plus the income and transfers it receives exceed its import spending plus the income and transfers it pays out.HL

current account surplus

Debt taken on by a government rather than by private individuals, households or firms — one of the four sections of the financial account.HL

official borrowing

Holdings of foreign currencies and liquid valuables for stabilizing payments.HL

reserve assets

Spending by multinational corporations in foreign economies.HL

Foreign direct investment (FDI)

The difference between capital transfers received and sent abroad.HL

Capital account balance

The difference between inflows and outflows of foreign direct investment.HL

Net FDI

The legal property rights to natural resources and intangible assets.HL

Transactions in non-produced, non-financial assets

The various types of financial flows in and out of a country, which may include international aid, debt relief, and funds moved by migrants.HL

Capital transfers

debt forgivenessHL

The cancellation of debt obligations, which can be a form of capital transfer in the balance of payments. It is significant for countries facing economic difficulties, as it can alleviate financial burdens and improve economic conditions.

economic powersHL

Countries that have significant influence in the global economy, often characterized by strong current account surpluses and the ability to affect international financial flows. They play a crucial role in global trade and economic stability.

transfersHL

Current transfers of money between countries, which can include private and government transfers. These are part of the current account and can affect the balance of payments.

An accounting method where every economic transaction involves a corresponding credit and debit, ensuring transactions are balanced.

Double-entry

Terms describing discrepancies found when calculating international financial records.

Errors and omissions

The difference between earnings from foreign investments and payments to foreign investors.

net income

State the formula: Current account

Current account = Capital account + Financial account Current account = Capital account + Financial account + Errors and omissions

Foreign exchange reserves

Assets held by a country in foreign currencies, which are crucial for managing international transactions and are used to pay for excess imports over exports.

double-entry accounting

An accounting method in which every financial transaction is recorded with corresponding credit and debit entries, ensuring that the balance of payments remains balanced. This technique aids in accurately tracking financial interactions between an economy and its trading partners.

trade in services

The value of services traded internationally, which includes exports and imports of services such as tourism, banking, and consulting. It is crucial for understanding a country's balance of payments and economic health.

A condition indicating that currency depreciation will improve a trade deficit only if the combined responsiveness of demand for exports and imports exceeds one.HL

Marshall-Lerner condition

An economic model showing the impact on a country's balance of trade after a currency depreciation.HL

J-curve effect

The small part of the balance of payments recording debt forgiveness, foreign currency flows, and the sale or purchase of non-produced, non-financial assets such as land and patents.HL

capital account

State the formula: PEDx + PEDmHL

PEDx + PEDm > 1 Marshall-Lerner condition: a devaluation or depreciation will correct a balance of trade deficit only if the sum of price elasticities of demand for exports (PEDx) and imports (PEDm) is greater than one.

currency devaluationHL

A deliberate reduction in the value of a currency by a government, intended to correct a current account deficit. Its effectiveness depends on the price elasticity of demand for exports and imports, as per the Marshall-Lerner condition.

inflows and outflows (credits and debits)HL

The movement of money into and out of a country, categorized as credits (inflows) and debits (outflows). This concept is essential for understanding the current account, which includes income from foreign investments and payments to foreign entities.

price elasticity of demand for exports (PEDx)HL

A measure of how responsive the quantity demanded of exports is to a change in their price. This concept is vital in determining whether a currency depreciation will effectively correct a trade deficit, as it must be combined with imports' elasticity to exceed one for effectiveness.

price elasticity of demand for imports (PEDm)HL

A measure of how sensitive the quantity demanded of imports is to changes in their price. It is part of the Marshall-Lerner condition, which states that a currency devaluation will only improve the trade balance if the combined elasticity of exports and imports is greater than one.

trade balance (X - M)HL

The difference between a country's exports and imports, which indicates whether it has a trade surplus or deficit. It is crucial for understanding the impact of currency depreciation on trade, as the balance can worsen before improving due to time lags in response to price changes.

demand managementHL

Fiscal and monetary policies used to influence total demand in the economy. Applied to the balance of payments, contractionary demand management lowers spending overall — and so lowers import demand — to correct a persistent current account deficit.

imported inflationHL

Inflation that occurs when the value of a domestic currency declines, leading to higher costs for imported goods. This can erode consumer surplus and negatively affect economic output, especially in countries reliant on key imports.

persistent current account deficitHL

A situation where a country consistently spends more on foreign trade than it earns, leading to a weaker domestic currency. This can result in imported inflation and negative impacts on national output and employment.