Balance Of Payments And Exchange Rates

Front 1

Define balance of payments?

Back 1

record of all inflows and outflows of money in and out of an economy

Front 2

3 components?

Back 2

current, financial and capital

Front 3

4 catagories to credits on the current account and explain them with examples?

Back 3

1. exports of goods - inflow

2. exports of services - inflow

3. income transfers - remitanes from Uk residents abroad back to the uk, interest earned abroad back to the uk and profits earned abroad by uk firms transferred to the uk

4. current transfers - gifts e.g. foreign aid

Front 4

4 debits on the current account and explain with examples?

Back 4

1. imports - outflow of currency

2. imports of services - outflow of currency

3.income transfers from foreign uk workers abroad and profits abroad and interest earned here transferred abroad

4. foreign aid to us

Front 5

define FDI?

Back 5

intevestment in at least 10% of foreign firms or purchase of physical assets e.g. offices

Front 6

3 eg portfolio invesment?

Back 6

stocks shares bonds

Front 7

Define financial account?

Back 7

records transactions between uk and row due to purchase of physcial and financial assets

Front 8

4 credits on financial account?

Back 8

1- FDI

2. portfolio incestment

3. financial derivatives

4. falls in foreign currency official reserves (means we are holding less of say USA assets)

Front 9

4 debits on financial account?

Back 9

1- fdi in other countries

2- porfolio investment

3- financial derivatives

4- rise in official foreign currency reserves (i.e. we hold more foreign assets)

Front 10

explain changes in official foreign currency reserves?

Back 10

a rise in foreign currency reserves mean an outflow of currency as we now hold more foreign assets so is a debit and vice versa

Front 11

2 things in the capital account?

Back 11

debt forgiveness + changes in assets due to migration

Front 12

rule of BOP?

Back 12

CA deficit = financial account surplus

Front 13

explain why BOP must balance?

Back 13

CA deficit means a fall in domestic foreign currency reserves which is a FA surplus therefore balance

Front 14

Long term capital flows, what do they represent?

2 things included?

Back 14

changes in decisions by investors to invest in assets in countries with a comparative advantage as they will gain a greater rate of return

includes portfolio and fdi

Front 15

short term capital flow alternative name, word to describe them, e.g.?

Back 15

hot money flows, speculative, currency transfers on forex markets

Front 16

effect of CA deficit on ER explain?

Back 16

implies a negative trade balance so more currency flowing abroad that here, so on diagram supply shifts outwards and causes a deprectiation - ceratus paribus should correct

Front 17

4 reasons why CA and ER autocorrect may not occur?

Back 17

1. 90% of currency transactions are not trade but speculative flows so probably won't autocorrect

2. ML condition

3. J curve

4. if caused by a lack of competitiveness(structuaral) probably won't be enough + just cause stagflation

Front 18

3 costs of a current account deficit?

Back 18

1. lower growth and higher unemployment

2. debt burdens may cause an economic crisis

3. exchange rate may depreciate and cause stagflation

Front 19

1. explain lower growth and unemployment with diagram?

Back 19

current account deficit implies a negative trade balance, so x-m is falling so fall in RGDP and rise in demand deficient unemployment

Front 20

2. debt burdens explain?

also fiscal problems ?

Back 20

CA deficit requires a FA surplus - easiest way to do this is for the government to issue debt (i.e. gov bonds + borrow from ROW), but if balloons out of proportion, fall in confidence to pay it back + currency and then financial and the economic crisis as people lose confidence and C and I fall - recision

crowding out and interest repayments

Front 21

3. explain depreciation?

Back 21

increase in supply of the currency so deprecation - in theory a good thing BUT no gurantee this will happen (ML, J , Speculation) and even so may not be enough to autocorrect CA deficit if caused by structural lack of competitiveness (UK) so import prices rise and stagflation may occur

Front 22

3. depends on for CA deficit?

Back 22

1. size - if very small percent of GDP not a problem to borrow but if more than 5% then a bad thing and may cause financial crisis

2. how financed - if financed by FDI + portfolio investment may reflect CA so not necessarily bad

3. type - cyclical (boom) vs sturtural

Front 23

possible adv of CA deficit?

Back 23

V strong AD and growth

Front 24

2 costs of CA surplus?

Back 24

DP inflation and a stagnating economy without enough demand (Japan)

Front 25

list 4 gov policy to correct a CA deficit?

Back 25

demand side (monetary or fiscal), protectionism, exchange rate devalue, ss policy

Front 26

explain 2 ways Demnad side would work?

Major Disadv?

Back 26

reduces demand for imports and reduces inflation (DP) making exports more price competitive

BUT COLLATERAL DAMAGE

Front 27

Protectionism, what type of policy?

BUT disdadv?

Back 27

Expenditure switching,

ALL Free trade adv

Front 28

Devaluation explain?

Back 28

x increase and i fall

Front 29

2 ways for SS policy?

Back 29

would reduce lack of competitiveness problem caused by e.g. NMW or TU + would increase investment in R and D

Front 30

2 evaluation points + diagram + explain?

Back 30

1. ML condition - if sum of PED of imports and exports greater than one only then will deprecitation improve a current account deficit

2. J curve - in the SR will deteriorate CA as ML condition not satisfied (as PED Of imports and exports likely to be inelastic in ST as fixed contracts and lack info) but in LR will improve as can rengeoicate.

Front 31

Define exchange rates?

Back 31

price of a currency in terms of another or commodity

Front 32

define a floating exchange rate + extra bit?

Back 32

where the price of a currency is determined exclusivley by the forces of supply and demand with no government/ central intervention and changes on a minute by minute basis (spot rate)

Front 33

what can you do in floating exchange rate? disadv? effect of cost of production?

Back 33

trade in futures market and hedge against risk, but Op cost of time + expensive so raises cost of production

Front 34

define a fixed ER ? what does this require?

Back 34

government or central bank fixes price of currency against another currency/commodity

requires huge domestic and foreign currency reserves

Front 35

define a managed exchange rate?

Back 35

gov intervenes if outside a certain range

Front 36

explain how fixed works with diagram when overvalued?

Back 36

gov sells the pound increases the supply and fall in price of pound SEE NOTES

Front 37

explain how fixed works if undervalued?

Back 37

gov sells FC and buy up pound increasing demand SEE NOTES

Front 38

what is an alternate way to fix ER? disadv?

Back 38

by using interest rates - IR up ER up

BUT huge collateral damange

Front 39

3 adv of floating ER? 4 eval

Back 39

independent monetry policy

Autocorrection of CA deficit

protects for high world inflation

4 eval points from earlier

Front 40

2 disadv of floating ER?

Back 40

inflationaray spiral - high inflation X fall and m rise so may cause ER to depreciate and cause rising import costs

uncerainty for domestic firms who may have to hedge - expensive

Front 41

3 adv of fixed ER?

Back 41

1- less uncertainty - FDI rises and reduces cost of production as firms don't have to hedge and production costs fall

2- control inflation through revalue/ devalue

3- discipline domestic producers and cant rely of low ER so x inefficiency falls

Front 42

4 disadv of fixed ER?

Back 42

monetry policy may not be indapendant - collateral damage

costly to have foreign currency reserves

lack of info so difficult to set

don't benefit from autocorrection of current acocount

Front 43

well done

Back 43

well done