Balance of Payments

Overview of balance of payments

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  • The balance of payments (BoP)
    • Measures all currency flows in/out of econ in a given time period
    • Capital account (Cpa)
    • BoP Equilibrium
      • Occurs when Ca more or less balances over few years
        • Balancing item needed to cover 'mistakes' so sheet sums to 0
    • Is a deficit a problem?
      • Long run?
        • YES
  • Current account (Ca)
    • The balance of payments (BoP)
      • Measures all currency flows in/out of econ in a given time period
      • Capital account (Cpa)
      • BoP Equilibrium
        • Occurs when Ca more or less balances over few years
          • Balancing item needed to cover 'mistakes' so sheet sums to 0
      • Is a deficit a problem?
        • Long run?
          • YES
    • Capital flows generate inward Iy
  • Policies to cure BoP deficit
    • Marshall-Lerner condition
      • J-curve
        • Is a surplus a problem?
          • Policies to cure BoP surplus
            • Is a surplus a problem?
              • One country's surplus is another country's deficiit
            • Measures income currency flows, payments for X and M
              • Current account (Ca)
                • Capital flows generate inward Iy
              • Net income flows
                • Investment income (profit and interest income generated from a country's assets abroad) (Iy)
            • Transfers are payments such as aid/gifts
              • Measures income currency flows, payments for X and M
                • Net income flows
                  • Investment income (profit and interest income generated from a country's assets abroad) (Iy)
            • LT capital flows
              • ST capital flows
                • Direct overseas investment (firms invest in/buy real prod assets)
                  • LT capital flows
                  • Portfolio overseas investment (purchase of foreign FA
                    • Hot money (speculative capital flows occurring when  banks or individuals buy a currency in order to earn a higher r/i  or when they expect an exchange rate to rise
                      • ST capital flows
                      • Short run?
                        • Nah
                      • Exchange rate
                        • Fixed
                          • Exchange rate
                          • Floating
                            • Problem because rate doesn't act as automatic stabiliser
                              • Fixed
                              • X automatically cheaper than M so Ca deficit somewhat managed
                                • Floating
                                • 3 D's
                                  • Policies to cure BoP deficit
                                  • Deflation (reduce AD)
                                    • 3 D's
                                    • Direct controls (protectionism)
                                      • Devaluation of currency
                                        • Expenditure-switching
                                          • Direct controls (protectionism)
                                        • Expenditure-reducing
                                          • Deflation (reduce AD)
                                          • Expenditure-switching
                                            • maps possible time path of Ca following devaluation
                                              • J-curve
                                              • Shows that after devaluation due to human behavior there is a  time lag before MPC changes so no immediate effect
                                                • maps possible time path of Ca following devaluation
                                                  • In the SR the Ca deficit actually worsens
                                                • when sum of X and M PED >1 then devaluation has effect on Ca deficit. Otherwise may worsen.
                                                  • Marshall-Lerner condition
                                                  • Reverse of 3D's
                                                    • Policies to cure BoP surplus
                                                      • One country's surplus is another country's deficiit

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