Note 9--Balance of payments

Balance of payment is the record of money coming in and going out from the circular flow of income in an economy. It is vital for a country to have adjust and balance this record that it may affect the status of this country in the world and the relationship with other countries.

Balance of payment includes current account,capital account&financial account and net errors:
Current account: It records all the transactions spent on the regular activities:
1) Trade in goods: It is also called visible account which includes import goods and export goods. e.g. oil, manufatured goods. From the information from http://www.tutor2u.com/,we can see that UK has been experiencing the trade deficit in goods until 1991.
2) Trade in services: It is often be considered as invisible account that it consists of import goods and export goods like mainly banking,insurance,tourism. Conversely with the situation of deficit in the goods,trade in most services has a high surplus compared with other countries ex cept the international travel and transportation. But it can be seen as an increasing income in the Uk that people have higher living standards and can afford to consume more internatioal tourism .
3) Net investment income from overseas: It arises from interest payments profits and dividends from from external assets located outside the UK. .
4) Net transfers: Transfers between countries or government transfers. e.g. UK government payments to help fund the various spending programmes of the European Union. In this account,the record is always negative in UK because it is totally a contributor to the EU budget.

Capital&Financial account: Direct investment. e.g portfolio investment like the purchasing shares between countrt and abroad.

Net errors: It records the mistakes made by the economy to ensure the balance of payment does balance.

Balance of payment deficit is always a problem and we just look for the causes:
1) Exchange rates is so high that it makes the import cheaper to the country.
2) An increasing aggregate demand with scarce resources will lead to a shortage and consumers have to choose some import goods.
3) High income elasticity of demand for import: It is said that as income goes up,they will spend more on the import goods which may cause the deficit by consumtion-led growth.
4) A decline in the capital investment.
5) As the supply-side problem,it is always more essential. Because high demand and insufficient supply,cost-push inflation will be caused which may reduce the competitiveness of products that fewer foregners will purchase them.

Then,it will lead to some effects like:
1) The inflation might be reduced because of the more demand for import goods and less demand for domestic goods.
2) Living standards may be increased as people have more choices and increasing ability to consume as cheaper prices of imports.
3) However,this will lead to a reduction in employment because of a lack of demand for domestic goods and investment.

To improve the balance of payments,we can use fiscal policy,monetary policy and supplu-side policy. But here,we can also use the devaluation,deflation and import control to reduce the exchange rate in order to reduce the trade deficit.
We can refer to the Marshall Learner Theorem which states that devaluation will improve balance of payments when the sum of the elasticity of demand for impoerts and exports is greater than 1.

Questions!!!I still don't know what are included in the capital&financial account?? There are a lot of different answers on the internet~