How does inflation affect the Balance of Payments? - The Student Room
How a fall in exchange rate can cause an improvement in current account balance of payments. Balance of payments · Economic growth · Inflation · Unemployment · Budget deficit · National debt the theory that would suggest there is a relationship between the exchange rate and the current account. recorded in balance of payments (BOPs), get adversely affected if the domestic price The relationship between the rate of inflation and different constituents of . Inflation and Balance of Payments (BOP) have no relationship. I want to add how inflation affects trade balance and foreign exchange rate.
Also, markets anticipate future inflation. If they see a policy likely to cause inflation e. How the exchange rate affects inflation If there is a depreciation in the exchange rate, it is likely to cause inflation to increase.
Import prices cheaper Why a depreciation causes inflation A depreciation means the currency buys less foreign exchange, therefore, imports are more expensive and exports are cheaper. After a depreciation, we get: The price of imported goods will go up because they are more expensive to buy from abroad Higher domestic demand. Cheaper exports increases demand for UK exports.
THere is also a reduction in demand for imported goods, shifting consumption to domestic goods Therefore, there is an increase in domestic aggregate demand ADand we may get demand pull inflation.
Less incentive to cut costs. Manufacturers who export see an improvement in competitiveness without making any effort.
Some argue this may reduce their incentive to cut costs, and therefore, we get higher inflation over the long term. Therefore, a depreciation causes both cost-push inflation and demand pull inflation. Example of depreciation causing inflation in the UK During andwe saw a significant fall in in the value of the Pound. Evaluation of impact on inflation The rise in UK inflation in was also due to higher oil prices.
It does not really matter where you enter the upward spiral to tell the story.
The Relationship between Balance of payments and Inflation by suheli sethi on Prezi
Start with wages going up and 'wage inflation' looks like the cause. Start with profits going up and increasing prices 'price inflation' looks like the cause. So as prices increase, profits increase correspondingly and automatically and are given to shareholders. Wages and salaries increase only after employees struggle to maintain the purchasing power of their take-home pay and then only to the extent to which their demands are satisfied.
The reality is that profits are inflation-proofed and that cost-of-living pay increases are achieved only as a result of struggle.Balance of Payments _ Part3 _ BOT & BOP _ Mauli Gupta
Say unemployment is low and labour is in demand. Increasing wage rates cause inflation. The argument then goes that one is fighting against inflation, that low or falling unemployment causes inflation so that to keep inflation down one has to increase unemployment or at least keep it above a certain level.
Exchange Rate and Current Account
In other words, one is supposed to keep unemployment up, or increase it, so as to prevent free-market competition for labour pushing wages up, as this would reduce profits. This piece of logical-seeming misleading argument is based on the untrue assumption that inflation is caused only, or mainly, by wage increases. Conveniently ignored by those putting forward such misleading arguments are all the other causes and relevant considerations mentioned in different places in this report including the effect of a country's balance of payments and consequent economic policies on the exchange rate and the purchasing power of its currency.
The calculations are simple, straightforward and illuminating. They show, for example, how devaluation weakening of a country's currency exchange rate is used to drive up profits instead of resulting in increasing competitiveness and output.
As a country's currency weakens, the country's exports need to be increased both in volume and in value by reducing prices abroad and in this way increasing sales. However, there is a strong temptation for manufacturers and exporters not to reduce prices below those being charged by their competitors abroad, but to be more than satisfied with the vast increase in profits which results from sitting back and doing nothing other than increase prices abroad in line with prices charged by one's competitors abroad.
The value of assets held abroad, and income from abroad, similarly increase in line with devaluation. Foreign held capital and foreign income appreciate as one's currency depreciates and there is then the tendency for capital to find its way abroad, when such capital should be invested within the country so as to improve its economic potential and for economic growth.
The enormous profit margins then cause production to move from high-wage to low-wage countries. The consequence is a lowering of standard of living in high-wage countries to that in low-wage countries, instead of a raising of standard of living in low-wage countries to that in high wage countries. Import goods and services which originate in low-wage countries, into a high-wage home country.
Transfer manufacturing and service work from a high-wage home country to low wage countries. Large additional profits result.
Inflation and Exchange Rates
Unemployment increases in the home country. There are many costs associated with unemployment such as social security payments to the newly unemployed.
The total cost to the community is the sum of all the items listed there. Companies, however, are not made to pay the resulting costs of unemployment, are allowed to pass these operating costs to the community and are thus making large profits at the expense of the community.
If he had carried out his threat the social costs would have been considerable and so he was jailed, presumably both as a punishment and to deter others from similar activities. They also do so for the sake of private profit but no action is taken to prevent them from doing so by recovering the social costs from them, or to punish and deter by punitive sentencing. All for the sake of profit, for personal gain of wealth, power, influence and control over others, for 'empire building'.
Transfer Pricing A multinational company can minimise its liability for corporation tax by transfer pricing, that is by making book entries which transfer profits to the country with the lowest corporation tax. This tax avoidance is legal and governments have not legislated to prevent this practice.
The government's income from taxation has decreased accordingly. As the government's expenses have not changed it must make up this shortfall elsewhere. Usually from its other taxpayers, say from its citizens.
So its citizens pay more tax, the government can now spend the same amount as before, the multinational's profits have increased. In other words, the multinational's increased profits arise from money which is in effect collected by the government by taxation from its taxpayers. The multinational, and this means the owners and directors of the multinational, are thus in effect taxing the people and in this way increasing the multinational's profits and thus their own incomes and wealth.
The Struggle for a Bigger Share Gainers and Losers Cutting back one's standard of living is not easy and here also the question arises how the burden should be shared. There are those who will attempt not only to maintain but improve their own standard of living while expecting others to bear the economies which have to be made and a harder life, and so conflict develops about how the burden should be shared.
Those who are well paid who gain a percentage increase gain far more in purchasing power than those who are badly paid who receive the same percentage increase and who in any case have to spend any increase on necessities. This applies equally to percentage markups such as profits and dividends. We need to look at the amounts rather than at percentages.
Inflation is used to concentrate purchasing power into the hands of those who are already well paid, into the hands of those who are already at or near the top, is used to concentrate wealth and power into the hands of a few.
In other words, inflation is used to redistribute income from the bottom to the top, concentrating purchasing power at the top and thus increasing differentials.
The country is in difficulties, fighting first for survival and then for economic success and strength. The standard of living is dropping so that attention concentrates on how to share out what is available, between those who run things and those who work. This attack on the living standards of the working population is misleadingly called a 'fight or battle against inflation' to persuade the working population to tighten its belts, to reduce its standard of living.
The arguments by which owners blame the employees' wage and salary demands for inflation while in turn the employees blame the owners' price increases are too often no more than propaganda aimed at increasing one's own slice of the national cake at the expense of the other 'side', at the expense of the rest of the community.
Just how one-sided this is can be judged by the fight supposedly being against 'wage inflation'. Left out of consideration are excessive price increases, profits, dividends or capital gains. Also more or less ignored is the large top-level remuneration which has been increasing yearly for some years at up to four or five times the rate of inflation, increasing each year by amounts many times exceeding the average income of the working population.
In such circumstances people work against each other instead of working with each other and we see conflict instead of cooperation. While profits, dividends and 'capital gains' increase automatically in measure with inflation, a bitter struggle develops as owners and employers attempt to use inflation as an excuse for reducing labour costs, that is wage rates, wages and salaries of the working population, so as to increase profits still further.
Employees are then not compensated for increased skill, experience and responsibility increased meritnor do they receive their share of the increasing national income and wealth the bettermentdo not receive merit increases and betterment increases. Pensioners also stand to lose betterment increases, do not receive their share of the increasing national income and wealth the betterment which is being achieved on the basis of their past labours.