THE BALANCE OF PAYMENTS STRUCTURE OF THE BALANCE OF PAYMENTS CURRENT ACCOUNT • • • Trade in goods and services. Investment Income Income generated by UK firms, from UK investment in other countries. CAPITAL ACCOUNT • FINANCIAL ACCOUNT Transfers Transfer of money into and out of the UK. SR Capital Flows Speculation, Hot Money – this is money that regularly flows between financial markets, looking for the highest short term interest rates possible (e.g. George Soros, Rogue Trader). LR Capital Flows FDI and assets (portfolio investment). • • SPECULATIVE FLOWS When a trader makes bets and guesses about different currencies - “hot money”. • FOREIGN DIRECT INVESTMENT (FDI) Direct investment from abroad – “inward investment”. • BALANCE OF PAYMENTS Difference between the amount of money coming in and going out of the country. The importance of exports: • • • • DEMAND SIDE CAUSES • • • • • Low interest rates à encourages investment. Discovery of oil. Consumers/investors expecting the exchange rate to appreciate, and for interest rates to fall. UK is a highly open economy Globalisation, commonwealth, general reputation, the EU, service exports. Export earnings are an injection of AD Exports help to stimulate economic growth. The UK is the 2nd largest service exporter (behind the US). Employment effects from exports TRADE DEFICIT Could affect suppliers and manufacturers. Regional economy and exports A trade deficit is a negative Helps to reduce structural unemployment. balance of payments in which THE UK’S CURRENT ACCOUNT RECORD • CAUSES OF HOT MONEY a country imports more than it exports. SUPPLY SIDE CAUSES Strong GDP Growth. Greater demand à firms earn more money à a need to import more to produce output. Increase in UK income, and greater availability of credit. A higher disposable income à more imports. Strong Pound. • • • Page 1 Low productivity. Less competitive – research and development gap. High productivity in other countries. E.g. China. Insufficient capacity from British producers. TRADE DEFICIT IS A PROBLEM FOR ECONOMY TRADE DEFICIT IS NOT A PROBLEM FOR ECONOMY • • • It can put serious pressure on a country’s currency. The recession in Britain in the early 1990s was largely due to huge deficits built up in the 1980s. There has been excess consumption - growth will have to slow down to bring the deficit down. • • The UK usually ends up relying on foreign direct investment or borrowing to make up the difference – it doesn’t matter in a globalised economy. The UK economy has survived the last 11 years without a recession. CONCLUSION: Although the UK economy has been fairly stable over the last 11 years, there is a risk that an ever-increasing budget deficit will put too much pressure on the pound, whilst driving economic growth down (multiplier effect). GOVERNMENT POLICY DEMAND SIDE POLICIES • • • SUPPLY SIDE POLICIES Money Supply Reduce the money supply à Less consumption à less A.D à fewer imports à more balanced balance of payments. Interest Rates Increase interest rates à consumers have a lower disposable income à less consumption à less AD à fewer imports. Taxation Increase the income tax rates (or brackets) à consumers have a lower disposable income à less consumption à less AD à fewer imports. • • Government Subsidies E.g. to improve UK competitiveness à more imports. Improve the skill set of workforce E.g. by attracting immigration. NULabour have increased spending on education (e.g. “The New Deal”). SR: Use demand side policies. LR: Use supply side policies. • • Page 2 Issue of time? Dramatic effects on the economy?