2.5 Balance of payments

• Balance of payments


  A record of all financial transactions made between consumers, firms and the government from one country with other countries
• Balance of payments


  • States how much is spent on imports, and what the value of exports is
  • Exports are goods and services sold to foreign countries and are positive in the balance of payments
  • Imports are goods and services bought from foreign countries, and they are negative on the balance of payments
• Components of the balance of payments

  • Current account
  • Capital account
  • Financial account
  • Balancing item
• Current account


  Includes all economic transactions between countries, such as trade in goods and services, income and current transfers
• Income transfers


  Net earnings on foreign investment as well as net cash transfers, including salaries and dividends
• Current transfers


  Transfers that have no return, such as aid and grants, including the payments the UK makes for being a member of the EU
• Capital account


  Involves transfers of the ownership of fixed assets
• Financial account


  Involves investment, such as direct investment, portfolio investment and reserve assets
• Balancing item


  Used to cover discrepancies where the components of the Balance of Payments do not balance to zero
• The components of the Balance of Payments should balance, with the sum of the accounts being zero
• Importance of achieving a sustainable balance of payments position

  • The UK government aim for the current account to be near to equilibrium
  • A balance of payments equilibrium on the current account means the country can sustainably finance the current account, which is important for long term growth
  • If it becomes difficult to attract sufficient capital flows, the pound could depreciate, leading to inflationary pressures
  • An imbalance suggests the UK is reliant on the performance of other countries, so UK economic performance will be affected if export markets become weak
• Current account deficit


  The UK spends more on imports from foreign countries, than they earn from exports to foreign countries
• Causes of balance of payments imbalances

  • Appreciation of the currency
  • Economic growth
  • Increased international competitiveness
  • Deindustrialisation
  • Membership of trade unions
• Current account surplus


  Capital and financial account deficit
• Current account deficit


  Capital and financial account surplus
• A surplus or deficit on the current account could indicate an unbalanced economy, and it could mean the country is too reliant on other economies for their own growth
• It could be difficult to attract sufficient financial flows in order to finance a current account deficit, making it unsustainable in the long run
• Policies to correct balance of payments imbalances

  • Fiscal policy
  • Monetary policy
  • Supply-side policies
• Fiscal policy


  Aims to reduce the quantity of imports by reducing disposable income or government spending, but can have negative impacts on domestic growth and competitiveness
• Monetary policy


  Expenditure-reducing policies aim to reduce demand in the economy, while expenditure-switching policies aim to switch consumer spending towards domestic goods
• Supply-side policies


  Aim to increase productivity and international competitiveness, but have a significant time lag before effects are seen