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Extract 2

Globalisation and balance of payments imbalances

Globalisation and Balance of Payments Imbalances

Extract 2

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Extract 2: Key Term Glossary

Key term Brief definition

Balance of Payments imbalances Persistent trade deficits or surpluses

Current account surplus Net external trade and income is positive

Current account deficitThe amount by which money relating to trade, investment income and transfers going out of a country is more than the amount coming in

Exchange rate index The trade-weighted value of a currency

Financial flows Flows of capital across national borders

Excess savings When gross national savings > investment

Capital account (BoP) Balance of investment flows

Depreciation Fall in the external value of a currency

Marshall Lerner ConditionA devaluation of a currency improves the BoP only if the combined (or sum of) price elasticities of demand for imports & exports are greater than one.

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Extract 2: Some Suggested Questions

1. Analyse two causes of a current account deficit in countries such as the United States

2. Analyse two causes of a current account surplus in countries such as China

3. Analyse why depreciation in the US dollar might not necessarily lead to a fall in their external deficit

4. Comment on two policies that might be used to correct a deficit on the current account of the balance of payments

5. Describe what is meant by balance of payments imbalances6. Distinguish between the current account and the capital

account of the balance of payments7. Distinguish between the current account and the capital

account of the balance of payments8. Evaluate the case for and against protectionism as a policy to

help prevent a recession and rising unemployment

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The Fast-Changing Global Economy

The world economy is changing rapidly! Since 1980 the share of global economic output has shifted towards Asian-Pacific countries who now dominate.

19.6%

22.7%

26.2%28.5%

31.4%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1980 1990 2000 2010 2015

US EU-28 Asia-Pacific

Percentage share of world GDP, at current market prices & exchange rates

Source: IMF World Outlook

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Extract 2: Text and Commentary

• While globalisation has brought about an increase in the volume of world trade, it has also increased balance of payments imbalances.

• Much of the discussion about these global imbalances has focused on China’s current account surplus and the USA’s current account deficit

• Imbalances refer to the persistent current account surpluses for some countries contrasted with large current account deficits in other nations.

• The main way of measuring trade / current account imbalances is as a % of GDP

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Extract 2: Text and Commentary

• The period between 2007 and 2013 saw fluctuations in the current account deficit of the USA and in its effective exchange rate index.

• Changes in its effective exchange rate (see Fig. 2.2) did not always have the expected impact on the USA’s current account deficit.

• The USA runs a permanent (i.e. a structural) current account deficit.

• Countries running external deficits normally see their currency depreciate

• The size of the US external deficit halved from 2007 to 2009 – in large part due to the recession.

• It has since been fairly stable at around $200bn per year

• But real growth in the US economy post crisis has brought about a fall in the deficit as a % of US GDP

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Fig. 2.1 Current Account Balances of China and USA

China’s current account surplus has more than halved since peaking > $400bn in 2008. It has also declined as a % of China’s GDP

The US current account deficit has narrowed from over $700bn in 2007 to under $400bn in 2009 and has remained fairly stable at this level since – declining as a share of GDP

Surplus

Deficit

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Current Account Balances of China and USA (% of GDP)

China’s current account surplus measured as a share of GDP has diminished significantly since peaking at 10% of GDP in 2007.

The surplus averaged 2% of national output in 2012-2014

Surplus

Deficit

% of GDP is a better measure of the scale of a deficit or a surplus

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Fig. 2.2 Effective exchange rate index of US dollar ($)

Depreciation

Appreciation

Base Year for the Index

100

95

9899

104

99

103

Overall, the US dollar has been depreciating against a trade-weighted basket of other currencies. But the size of the changes in percentage terms in the external value of the $ have been small.

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US Dollar – Chinese Yuan Exchange Rate

China ends their fully-fixed exchange rate against the US dollar

Yuan per $1

Yuan appreciating v $

Effective return of a fixed exchange rate during the global financial crisis

China devalues the Yuan in summer of 2015

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How changes in the exchange rate affects trade balance

Depreciation in market value of the

US $

$ has fallen in value e.g. v Chinese Yuan

US goods and services cheaper in

foreign currency terms

Imports into the USA more

expensive prices in US $s

Demand for US exports should rise

Demand for US imports should fall

Ceteris paribus, value of US exports

will rise

Ceteris paribus, value of US imports

will fall

So the US trade deficit should reduce in size!

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Will an Exchange Rate Depreciation improve the BoP?

Time period after depreciation

Trade surplus

Trade deficit

Currency depreciation

here

Trade deficit may grow in the initial

period after depreciation

Net improvement in trade provided certain conditions are met –

known as the Marshall Lerner condition

The diagram below shows the “J Curve effect” – it shows the time lags between a falling currency and an improved trade balance