P.38. The balance of payments.

The pattern of the UK trade-

UK is very dependant upon IT(M=32% o f GDP, X=29% GDP). As GDP increases the IT increases!

Mostly trades with finnished manufactured goods (52.5%)

The components of trade are changing because.

1.    Visible trade (negative), now North Sea oil.

2.    Invisible trade and tertiary sectors are improving (City, tourism!, positive)

UK exports low value bulk products and imports few high value products.

The direction of trade.

70% to EU. 65-70% with 10 countries.

Unusually wide pattern of trade.

The terms of trade.

Measure of relative prices of exports and imports = x100

If index increases - favourable and vice - versa. The favourable is beneficial only if demand for export is inelastic, otherwise the quantity might decrease.

The Balance of payments- includes everything below.

The balance of payments is an account of all the transactions of everyone living and working in the UK with the rest of the world.

Balance of payment always balances. In the short term balance is achieved through official reserves.

1.    Current account (or balance) - Balance of payments on current account.

a.    Visible trade - Balance of trade

b.    Invisible trade - invisible balance

2.    Transactions in external assets and liabilities - involve movement of capital(money), not goods.

Usually negative and fluctuating because of the "hot money". UK is one of the biggest investors!

a.    UK investment overseas

b.    Overseas investment in UK

c.    Borrowing and lending overseas by UK banks

d.    Changes in official reserves - reserves of gold, foreign currency etc. Increase is shown as (-) in the B o P account (since reserves are in foreign currency that is changed £).

e.    Government loans to foreign countries and other.

3.    The balancing item - statistical errors.

The problems of a surplus.

1.    De industrialisation

2.    Feedback effects (trading partners might limit import)

3.    Inflationary consequences

4.    Depression of domestic living standards (surplus could be turned to imported goods)

Curing supply - inflate economy or revaluate currency.

Deficit problems:

1.     Short term problems

2.     Long term problems

Curing deficit:

1.     Expenditure reducing (domestic deflation)

Restricting the total level of demand by fiscal and monetary policies. Used if country wishes to maintain fixed exchange rate policy, protective measures might conflict with GATT and invite retaliation. The cost of it is high for unemployment.

2.     Expenditure switching (import controls, protection (look 37), devaluation)

To be effective demand for import must be elastic.

Policy depends upon size, cause, and current exchange rate policy:

   Size - how big in which sector (no problem if - ive in investment etc.)

   Cause - determines what policy to use

   Exchange rate policy - a fixed interest rate policy limits the options

3.     capital market - interest rates (expensive, dangerous) and exchange control.

J-Curve-attempt to cure B o P (by devaluation) leads to even more deterioration is short term , but to recovery in the long-term:

1.     Crises of confidence

2.     Insufficient capacity

Keynesian view of B o P = absorption approach

Monetarists view = problems are monetary (exchange rate control + tight monetary policy)

Stages of development of the B o P.

Lower income economies (Ghana), lower - middle (Nigeria), upper middle(Brazil), High income oil (Saudi Arabia), Industrial market economies (UK), non-market industrial economies (socialist states).

Deficit problems:	Suggested remedies
Inflationary problems- export too low, prices high (UK 1989)	Increase productivity to lower prices and increase exports
Interest rates low - hot money flows out	Tight fiscal policy and dear money policy, maybe higher interest rates
Currency overvalued - unemployment, low X	Devaluate if M/X elasticities are favourable
Capital outflow because of too much investment or government expenditure overseas	Stop to reduce drain, e.g. Exchange control regulations on investment
Surplus problems: Spare capacity, exports high, prices low (GBR 1982)	Easy fiscal and cheap monetary policy, with low taxes and high govn expenditure - boost internal economy and "hot money" flows in.
Currency overvalued - embarrassing to trading partners, X cheap and M dear, domestic living standards restricted. (Japan 1983)	Revaluate currency. Increase capital investment overseas and foreign aid.