Balance of payments - trade imbalances
What is a balance of payments crisis?
A BofP crisis occurs when a country cannot pay for essential imports and service its debt (i.e pay interest), often as a result of currency devaluation; usually preceded by large capital inflows in order to boost growth but then investors get worried about their debt and remove their capital.
Why might a trade deficit be beneficial?
Especially for a developing country, a trade deficit can bring benefits. Economists might justify a trade deficit by arguing that poorer nations should be importing capital by running a current-account deficit. Providing productive investments are made, this gives a country the extra capital to drive future GDP growth so it can pay the foreigners back. o In the Short term, if a country is importing a high volume of goods and services this is a boost to living standards because it allows consumers to buy more consumer durables (cars etc.) o The deficit might also be the result of importing much needed capital equipment that will boost a country's productive capacity in the long run
What is the definition of a current account deficit?
there is a net outflow of demand and income from a country's circular flow. This means, trade in goods and services and net flows from transfers and investment income are taking more money out of the economy than is flowing in. Aggregate demand will fall. - draw diagram
what are trade imbalances?
o The Global economy will always have some deficit countries and some surplus countries o The Scale of global trade imbalances has increased over the years and this has created tensions between nations and poses a threat to globalization -->Deficit countries include = USA and UK --> Surplus countries include = China and Germany o Most countries are using managed exchange rates as a way of dealing with growing trade deficits Managed exchange rates= it is floating but the government intervene to a point
What are the key dangers from running persistent trade deficits?
o can lead to lower AD and slower growth - arising from net leakage o lead to a loss of jobs - increase in output gap and so on o currency weakness and higher imported inflation - demand for pounds fall o currency weakness can lead to capital flight/ loss of investor confidence - panic selling o run short of vital foreign currency reserves - limit to how central bank can keep purchasing currency to maintain its value o deficit countries need to import financial capital to achieve balance - inflows of hot money and hot money allows the UK to run a currency account deficit. o conc- in long run, persistent trade deficits undermine the standard of living - competitiveness needs to improve o trade deficit is a reflection of lack of price/non- price competitiveness.
What are the main causes of a structural trade surplus?
o export orientated growth = investment in new capital provides the means by which economies can be exploited, unit costs driven down and comparative advantage can be developed. o FDI - foreign affiliates establish production plants and then export from this base o Undervalues exchange rate - keeping exchange rate down o High domestic savings rates - High levels of domestic savings and low domestic consumptions of goods and services o Closed economy - protectionism, low share of national incomes taken up by imports- o Strong investment income from overseas investment- it might be the profits coming home from the foreign subsidiaries of MNC's, or the interest from money held on overseas accounts, or the dividends from taking equity stakes in foreign companies.
