LS9 Booklet

• economies are interconnected through international trade
• the balance of payments is split into two main parts: the current account and the capital and financial account
• the current account records payment for the exports and imports of goods and services
• the capital and financial account records saving, investment and other flows of money
• Globalisation means global economies becoming more interconnected
• gloablisation can occur when the output of an economy which is traded internationally is growing
• globalisation occurs when there is an increase in ownership of financial assets
• globalisation occurs when individuals migrate in increasing numbers to other countries
• globalisation occurs because technology is being shared between countries on a faster basis
• deficit of BOP occurs when inflows become smaller than outflows as demand for foreign goods increase
• surplus of BOP occurs when inflows become larger than outflows. usually happens in current account (as that is where exports are recorded) or in the capital/financial (as that is where foreign investments are recorded)
• a deficit equilibrium is known as unfavourable balance
• a surplus equilibrium is known as favourable balance
• persistent surpluses can lead to inbalances and global tensions
• A large BOP surplus can lead to inflationary pressure due to excess inflow of foreign currency. this will increase the domestic money supply
• A large BOP surplus can lead to more pressure on the domestic exchange rate. An overvalued currency can harm exports and promote more imports which will lead to trade imbalances
• if a BOP surplus is caused by excess saving or under consumption, it could indicate a misallocation of resources and so the domestic economy would fail to reach its potential capacity
• causes of surplus on BOP:

  • high export levels
  • low import levels
  • remittance inflows
  • high income from investment
  • large capital inflows
  • exchange rate policies
• high export levels cause surpluses because if a country produces high quality goods at competitive pricing, it may have a strong export performance. also a country‘s exports may have strong global demand
• Low import levels cause surpluses because high tariffs and other trade restrictions will reduce imports and lead to a surplus. Also, countries that produce sufficient goods domestically will rely less on imports
• Strong remittance inflows cause a surplus because countries with a large number of citizens working abroad often recieve inflows that they can send home
• A country with lots of investments abroad may recieve lots of interest, dividens or profits which will increase income inflows and cause a BOP surplus
• high levels of foreign investment in domestic markets can create a surplus. borrowing from foreign countries or receiving financial aid contributes to capital inflows
• undervalued currency is when a currency has a low exchange rate which makes exports cheaper and imports more expensive. Exports become more attractive to foreign buyers, boosting trade surplus
• causes of deficit in BOP:

  • population growth
  • development programmes
  • demonstration effect
  • natural factors
  • inflation
  • globalisation
• population growing at a faster rate means more needs are to be fulfilled. therefore, imports become essential and so the quantity on imports increases as population increases.
• Development programmes - developing countries may import raw materials and highly skilled labour that are not available in their countries
• demonstration effect: when people in less developed countries imitate the consumption pattern of the people in the developed countries. This makes their imports increase
• Natural factors such as no rain and large floods will affect the agriculture and industrial production in the country. This would cause exports to decline and imports to increase, causing deficit in BOP
• an increase in income and general price level causes inflation. This will lead to rapid development in developing countries, which will increase imports and reduce exports. This causes a deficit in the BOP
• Globalisation allows for a more flexible movement of goods between countries. This allows for more competition which can cause a deficit in some countries BOP due to more imports than exports
• Fiscal policy is the use of government spending and taxation to influence the economy
• Monetary policy is action taken by the central bank to influence the economy by controlling money flow. This may be by setting interest rates and changing the money supply
• deflation is used as a measure to correct deficit disequilibrium
• deflation is brought about through monetary policies or by fiscal policies (higher taxation, lower public expenditure)
• deflation would make a countries exports cheaper in foreign markets results a rise in that countries exports. the demand for imports will fall due to higher taxation and reduced income
• exchange depreciation means a decline in the rate of exchange of the domestic currency in terms of a foreign currency. This implies that a country has adopted a flexible exchangle rate policy
• exchange depreciation will increase exports and reduce imports as exports become cheaper and imports more expensive
• devaluation is when the exchange rate is deliberately lowered through monetary policies
• governments may implement policies to restrict foreign exchange outflows. These policies could limit the amount of foreign currency we can access. This reduces imports and encourages domestic production