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					Balance of Payments
Definition of the Balance of
Payments

• The balance of payments is a record of one
  country's trade dealings with the rest of the world.
  Any transaction involving UK and foreign citizens
  is calculated in sterling (UK pounds).
• Dealings which result in money entering the
  country are credit (plus) items while transactions
  which lead to money leaving the country are debit
  (minus) items.
Definition of the Balance of
Payments
The balance of payments can be split up into
two sections:

1. the current account which deal with international
   trade in goods and services;
2. transactions in assets and liabilities which deals
   with overseas flows of money from international
   investments and loans
Current Account

• The current account consists of international
  dealings in goods (visible trade) and services
  (invisible trade).
• Invisible trade includes payments for overseas
  embassies and military bases: interest, profit and
  dividends from overseas investment; earnings
  from tourism and transportation.

   The UK in Global Economy:
   • UK Balance of Payments, 2003 in £ millions –
     Current Account
Transactions in Assets and
Liabilities

The transactions in assets and liabilities section of the
balance of payments shows all movements of money in and
out of the country for investment.
This may be direct investment - investment in productive
capacity, or portfolio investment - investment in shares or
other assets. Changes in assets will be outflows from the
UK, as UK investors invest money overseas.
These flows will be debits to the UK Balance of Payments.
Changes in liabilities will be credits to the UK Balance of
Payments as overseas investors invest money into the UK
UK trade balances with EU and Non-
EU countries (£bn, quarterly)




    Click on image for further details
Balance of Payments Problems
Correcting a Balance of Payments
Deficit
• Strictly speaking, the balance of payments always
  balances because of official financing.
• However, a balance of payments deficit means a
  persistent and large negative balance for official
  financing. This can be the result of excessive
  purchases of foreign goods and services or
  excessive UK investment overseas. In the short
  term, a balance of payments deficit can be
  corrected by:
 Correcting a Balance of
 Payments Deficit
• continued borrowing of foreign currency;
• increasing interest rates to attract overseas
  investors;
• imposing exchange controls;
• imposing tariffs and import quotas.

 In the long run, the government can correct a balance
 of payments deficit by reducing demand in the
 economy for all goods including imports. Reducing
 UK inflation rates or encouraging a sterling
 depreciation will also help.
Correcting a Balance of
Payments Surplus

An unwanted balance of payments surplus can
be the result of excessive foreign investment in
the UK. This will place a future strain on the
invisible balance. A reduction in interest rates or
restrictive exchange controls will correct the
surplus.
Exchange Rates

An exchange rate is the price of one currency in
terms of another. For the UK, the dollar exchange
rate means the number of dollars ($) one pound (£)
can buy. The exchange rate is determined by the
supply and demand for sterling (pounds) and is $2
per pound in the diagram on the next page
Exchange Rates
Demand for Sterling

Americans want to exchange dollars for pounds for
two reasons:
• to buy British goods and services;
• to lend or invest in the UK.
The diagram on the previous page shows the
number of pounds demanded at each and every
exchange rate. This is the D curve.
Supply of Sterling

Britons want to exchange pounds for dollars for two
reasons:
• to buy American goods and services;
• to lend or invest in the USA.
In the diagram above S shows the number of
pounds supplied by Britons at each exchange rate.
Changes in the Exchange Rate

A fall in the value of sterling (depreciation) means
one pound now buys fewer dollars. Sterling
depreciates if Americans
demand fewer pounds (shown in the diagram below)
or if UK citizens offer more pounds. UK exports
become cheaper and UK imports become dearer.
Hence, a sterling depreciation improves the balance
of payments.
Changes in the Exchange Rate




A rise in the value of sterling (appreciation) means one pound now buys
more dollars. UK exports become dearer and UK imports become
cheaper. Hence a sterling appreciation worsens the balance of
payments.
References and Further Reading

These pages are based on original material written
by Richard Young of Wood Green School Witney.
Content has been updated and diagrams added by
Biz/ed and Finntrack

Also see: UK Balance of Payments

				
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