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Economics
BALANCE OF PAYMENTS
Introduction

- Balance of payments: a record of a country's economic transactions with the rest of
the world over a year

- Components:
1
...
Capital account
3
...
Net errors and omissions

1
...
Trade in goods (visible trade):

- Trade in goods = visible exports - visible imports
- A surplus means that exports of goods > imports of goods, while a deficit
means that exports of goods < imports of goods

- Exports are additions to credit items, while imports are additions to debit
items

- Total trade in goods add to the (X-M) in the AD equation; the more visible
exports you sell, the higher the chances of economic growth
...
Apply the same concepts to the trade in services (invisible trade)
C
...

D
...
He
decides to send 10000 USD to you
...


- In some countries, many people from abroad continuously send money in,
resulting in a large sum of money flowing in (credit)
...

2
...
Government debt forgiveness: this is the partial or total forgiveness of debt
owed by individuals, corporations, or nations by a government
...
The 500-dollar
relief is government debt forgiveness
...

So the 1 mil USD is the government debt forgiveness from the USA
...
Disposal and acquisition (this means buying) of assets: When assets i
...

natural resources and factors of production become worn out and obsolete,
they are thrown out and replaced by new ones
...
The disposal and purchase of old and
new assets add up to the credit and debit of the capital account
...
Capital transfers: Money brought into (credit) and out (debit) of a country by
immigrants (self explanatory), gift and inheritance taxes
3
...
Direct investment: This means capital investments by firms and companies
...
An
example of capital investment is building a new factory
...
This
generates investment income in the current account
...
Portfolio investment: This is investment done by people who are not part of a
company or firm
...
This generates investment income
in the current account
...
Other investments: Short-term financial investment such as bank loans and
inter-government loans
...
For example, the government of India owes the government of US
a debt of 10000 dollars with a 5% interest
...
This also adds
to the investment income in the current account
...
Reserve assets: Foreign exchange reserves
...
The government has to
have a lot of foreign exchange reserves in order to buy/sell an amount of their
currency that is enough to influence the demand/supply
...
Reduction to these reserves add to credit items
...
(Inflow of
money)

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Effects of inflation on current account and economic growth rate

- When a country experiences inflation, prices of exports rise and become less price
competitive in comparison to the now cheaper imports
...
Import expenditure increases and export revenue falls
...


- A decrease in total trade will result in a current account deficit
...


- It works the opposite if your country is experiencing deflation
...


How do governments prevent a current account deficit and slow economic
growth?

- Protectionism
...
This way demand for imports fall and demand
for domestic goods will arise
...


- The government can do so by implementing import tariffs (taxes on imports) so that
the market price of imports will rise
...


- The government can also use quotas
...
As a quota is implemented to
reduce the import spending, supply of imports will decrease
...


- Aside from making imports expensive through quotas and tariffs, exchange control
can be used to decrease the amount of foreign currency bought by consumers in the
country
...
Import expenditure will decrease, and the deficit in the current
account will fall
...
This
way import revenue will fall and the current account will restore itself
...
For example, US decides to decrease its exports to Japan
...
As the amount of imports in Japan
falls, import expenditure falls and the current account deficit will be less
...

After a depreciation, exports will be more expensive
...
However, it requires demand for exports and imports to be relatively price
elastic
...
The actual value of exports can decrease
...


- Note that when writing anything about exchange rates, demand for exports and
imports, always state the PED
...
Assuming PEDx is elastic, the demand for exports will
fall, decreasing export revenue
...

A fall in demand for exports will also lead to a deficit in the current account of the
BOP
...
This causes a fall in
the (X-M) component of the AD
...


Methods to correct disequilibria in the BOP:

- Deficits in the current account can be offset by surpluses in the financial account
...
Expenditure Reducing Policies

• These are policies to reduce spending entirely (doesn't matter if the spending is
on exports or imports, this method's objective is to reduce consumption in
general)
...
Contractionary monetary policy: The increasing of interest rates by the central
bank (Bank of Indonesia for our country)
...
As consumers have lower disposable income, they
will not have as much money to buy goods and services
...
As spending decreases, spending on imports
will decrease as well
...
This lowers aggregate demand and is especially useful if a
country is experiencing demand-pull inflation
...
Contractionary fiscal policy: Increase in income tax
...
They will have less
money to spend on goods and services
...
Increase in indirect
taxes (sales tax) also contributes to decreasing spending
...
This will reduce AD
...
(Use demand-pull inflation logic) A fall in inflation
rates means that prices of exports decrease and exports (domestic goods)
become more price competitive than imports
...
There will be an improvement of total trade in the current account
...

2
...


• Total trade in goods and services in the current account will improve and this will
offset or decrease the current account deficit
...
(Protectionism)

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