Balance of Payments and Exchange Rates

What are some key components of invisible trade?

• Services: tourism, transportation, professional services

• Interest, profits, and dividends from foreign investments

How do invisible exports and imports differ?

• Invisible exports: services sold to foreign countries (e.g., UK tourism)

• Invisible imports: services purchased from foreign countries (e.g., overseas insurance)

What is the current account?

• Record of trade in goods and services, income flows, and current transfers

• Can result in a surplus (more inflows than outflows) or deficit (more outflows than inflows)

What are capital transactions?

• Financial flows related to investments and loans

• Examples: foreign direct investment, portfolio investment, government borrowing

Why does the balance of payments always balance?

• Double-entry bookkeeping system ensures credits equal debits

• Any deficit in one account is offset by a surplus in another or by changes in reserves

What is the balance item (or balancing item)?

• An entry to account for statistical discrepancies and unrecorded transactions

• Ensures the overall balance of payments sums to zero

What is an exchange rate?

• The price of one currency in terms of another

• Determined by supply and demand in foreign exchange markets

What influences the demand for a currency (e.g., pounds)?

• Exports of goods and services

• Foreign investment in the country

• Speculation on currency appreciation

What affects the supply of a currency?

• Imports of goods and services

• Domestic investment abroad

• Speculation on currency depreciation

What are the main functions of the IMF?

• Helping countries with balance of payments problems

• Encouraging currency convertibility

• Promoting exchange rate stability