Balance of Payments Disequilibrium - Causes and consequences - YouTube

In the following video we will look at the concept of equilibrium in the balance of payments.

We will discuss causes of disequilibrium with a primary focus on the current and financial

accounts.

When we discuss disequilibrium in the balance of payments, we are generally discussing the

state of one of the accounts - the current account, the capital account or the financial

account.

We saw in the previous video why the balance of payments always balances, but we need to

examine the factors that cause one of the accounts to tend towards disequilibrium, or

where there is surplus or a deficit in the account.

In order to achieve equilibrium, the debits and credits on the specific accounts of the

balance of payments must be equal.

In this video we will focus mostly on the factors that cause disequilibrium in the current

account and will dedicate the remaining time to the financial account.

Since the capital account is a minor concern, we will focus on the previous two.

In the current account, export revenue should equal import expenditure or an imbalance exists.

There could be a variety of reasons that export revenue is greater than import revenue and

vice versa.

If a country’s export revenue is less than its import expenditure, the country is said

to have a trade deficit which could also indicate a current account deficit.

To determine whether there is absolutely a current account deficit, we need to also factor

in current transfers and income as well.

If the export revenue is greater than import expenditure, the country is said to have a

trade surplus which could also indicate a current account surplus.

To determine whether there is absolutely a current account surplus, we need to also factor

in current transfers and income as well.

The first series of causes of disequilibrium will focus on the current account.

They will be highlighted in green.

Discussion of factors that affect the financial account will be highlighted in amber.

As an economy experiences economic growth and its citizens become richer, there is a

tendency to import more, moving towards a greater amount of money spent on imports than

is received on exports.

A decrease in economic growth or a recession will lead to a decreased demand for imports

resulting in a tendency towards a current account surplus and away from the deficit.

If the price level rises in a country relative to its trade partners, it makes its exports

less attractive and decreases the likelihood of exporting.

This can lean the current account towards a deficit depending on the extent of the change

of the price level.

Currency fluctuations have similar effects.

If the currency appreciates, it is likely to reduce export revenue and increase import

expenditure, resulting in a tendency towards a current account deficit.

If the currency depreciates, it is likely to increase export revenue and decrease import

expenditure, resulting in a tendency towards a current account surplus.

Trade policies could impact the current account and the financial account.

They could impact the current account by limiting or increasing trade with other countries.

This could also positively or negatively influence the level of foreign investment into a country.

If trade policies encourage more free trade, it may lead to greater import expenditure

yet attract greater foreign investment.

The opposite also holds true.

If trade policies are protectionist in nature, it may lead to less import expenditure and

deter foreign investment.

Foreign investment will increase if an economy is attractive to foreign investors.

This could be due to supply side changes, political stability and an overall level of

confidence in the government and economy.

The United States runs a current account deficit but attracts a lot of foreign investment,

which results in a financial account surplus.

Finally, we will consider the consequences of disequilibrium.

This list is not exhaustive but demonstrates the impact on the domestic and external economy.

Increased reliance on imports drives up the risk of imported inflation.

If a country imports raw materials and commodities and is reliant upon imports as the primary

source, they are vulnerable to fluctuations in their prices and in the exchange rate - for

better or for worse.

Over reliance on trade partners as export markets.

If a country has a large export market, its economy’s performance is largely tied to

the performance of its trading partners.

If its trading partners suffer economic downturns, this will have a significant effect on a country’s

economy.

This could signal a weaker economy and deter foreign investment.

If a country is seen to consistently run a current account deficit, it may be a sign

that consumers and businesses are continuing to opt for goods and services produced outside

of the country.

If this continues for the long run, it may signal little confidence in domestic production

and choice, deterring foreign investors from exploring investment opportunities.

That wraps us this video on the balance of payments and I hope you’ve been able to

better understand the conditions of disequilibrium, its causes and consequences.

If you have any questions or comments, leave them below or email me at [email protected]

or tweet me @enhancetuition.

As always, thanks for watching and I will see you in the next one.