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The Balance of Payments. Definition and structure. Balance of payments. overall view of transactions with the rest of the world. Made up of three separate accounts Current Account Capital Account Financial Account. Balance of Payments – Current Account.

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The Balance of Payments

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The balance of payments

The Balance of Payments

Definition and structure

Balance of payments

Balance of payments

  • overall view of transactions with the rest of the world.

  • Made up of three separate accounts

  • Current Account

  • Capital Account

  • Financial Account

Balance of payments current account

Balance of Payments – Current Account

  • It is a record of all money flows from international transactions between the Kz and the rest of the world

  • Trade in Goods

  • Trade in Services

  • Investment Income

  • Capital Transfers

Trade in goods visibles

Trade in Goods (visibles)

  • Consumer Durables

  • Capital Goods

  • Commodities

  • Components

  • Foodstuffs and Beverages

Services invisibles

Services (invisibles)

  • Tourism

  • Financial Services

  • Insurance

  • Music and entertainment

  • Banking

Financial account investment income

Financial Account: Investment Income

  • Investment in companies overseas,

  • And their investment in us

  • FDI Foreign Direct Investment.

  • Other investments e.g. Loans to banks.

Capital transfers

Capital Transfers

  • Transfer of money between individuals

  • Kazakhs working overseas

  • Grants to overseas countries

  • Contributions to International organisations e.g. IMF, World Bank and WTO.

Capital account

Capital Account

  • Acquisition or disposal of Non produced or non financial assets.

  • Capital transfer credits

  • Donation from Canada to Tanzania for schools

  • Dr from Canada Cr to Tanzania

  • Capital transfer debits

  • UK to finance an Airport St. Helena.

Debt forgiveness

Debt forgiveness

  • If Rwanda relieved of its debts = Cr in Rwanda’s capital account.

  • If a bank in Switzerland , which made a loan to government of Sierra Leone waived that debt = Dr in Switzerland’s Capital Account.

Foreign exchange reserves

Foreign Exchange Reserves

  • If there is a deficit in the Balance of Payments the government will draw on reserves to rectify the deficit and support the exchange rate.

Current account

Current Account

Uk deficit narrows

UK Deficit Narrows

of which: EU  £3.2    non-EU  -£10.9

Trade in goods deficit widens

Trade in Goods Deficit Widens

Consequences for japan balance of payments surplus

Consequences for Japan Balance of Payments Surplus

  • Positive Current Account balance.

  • Country has a high demand for exports

  • High demand for local currency

  • Leads to appreciation of currency value

  • Makes M cheaper

Consequences for usa of a balance of payments deficit

Consequences for USA of a Balance of Payments Deficit

  • Negative Current Account Balance

  • Means that another part of the account must be in surplus to create a balance of money.

  • The magnitude of the deficit is important, measured as a % of GDP

How to fix a large current account deficit

How to fix a large Current Account Deficit

  • Encouraging people to buy locally produced products.

  • Devalue currency

  • Reduce AD.

Demand supply side causes of deficit

Demand & Supply side causes of deficit

  • Short-term factors eg Strong consumer demand –

  • Leads to a very high level of demand for imported goods and services

  • UK consumers have a high income elasticity of demand for overseas-produced goods

Demand supply side causes of deficit1

Demand & Supply side causes of deficit

  • The strong sterling exchange rate in the past has helped to reduce the UK price of imports causing expenditure-switching effect

  • weakness of the global economy and in particular the very slow growth in the Euro Zone has damaged UK export growth.

Causes of deficit in uk

causes of deficit in UK

  • 55% of all UK X go to EU

  • shifts in comparative advantage (China)

  • The availability of cheaper M inevitably causes a substitution effect from British consumers

Causes of deficit

Causes of deficit

  • Weak product innovation and R & D

  • The UK manufacturing sector has been in long-term decline for more than twenty years.

  • Lack of productivity, inflexible labour market

Implications of a deficit

Implications of a deficit

  • There is a net outflow of demand and income from the circular flow of income and spending.

  • The currentaccount need not balance as long as the financial account is in surplus – need to attract investment, savings etc

  • The UK has run large currentaccount deficits in with barely any effect on the overall economy.

  • Small chance of speculative selling of sterling on the foreign exchange markets

Implications of a deficit1

Implications of a deficit

  • If the deficit is due to very strong consumer demand, it automatically self corrects when the economic cycle turns

  • increased imports of new capital & technology which improves productivity in LR could cause deficit – not a problem

  • A widening trade deficit may result in lost output & employment because it represents a net leakage.

Implications of a deficit2

Implications of a deficit

  • Foreign investors may eventually take fright, lose confidence and take their money out.

  • Deficit represents an S>D of the currency in the foreign exchange market

  • can lead to a  Price therefore exchange rate

The balance of payments


Surplus on the current account


Deficit on the current account

Net improvement

Point when currency depreciates

Terms of trade

terms of trade

  • = the rate of exchange of one good or service for another when two countries trade with each other. 

Terms of trade index

Terms of Trade Index

  • ToT = 100 x Average export price index / Average import price index

  • If export prices  faster than M prices, .

  •  D X  and D M 

  • If import prices   faster than export prices, the terms of trade have deteriorated



  • On your boards write two important things you have learned about the Balance of Payments.

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