Economic forces

Four key economic forces influence a country’s balance of payments flows.These are the relative inflation rate, real GNP growth rate, relative interest rates, and the spot rate of exchange.(Table 1.3)

Table 1.3　Balance of payments adjustment to economic forces

The inflation rate should be considered in a relative sense.For example, if France has an annual inflation rate of 3％, and the UK has an annual inflation rate of 10％, the excessive level of price increases in the UK will have an effect on the competitiveness of UK versus French goods and services.Eventually, a number of UK goods and services will lose their competitive position to similar French goods and services.UK imports from French will rise.The balance of payments of the UK will reflect this increase in imports.Similarly, the balance of payments of France will experience an increase in exports.At the same time UK exports to France may level off and decline, while French imports from the UK will decline.

Real GNP growth affects the level of goods and services imports.A country experiencing high and rising real GNP growth tends to have a higher volume of imports.A country with a lower real GNP growth tends to import fewer goods and services.

Differences in interest rate levels can exert a powerful effect on international capital flows.Countries experiencing a high or rising level of interest rates usually experience capital inflows, based on the desire of non-residents to benefit from the higher interest rates available.These transaction flows are represented in the capital account of the balance of payments.Countries with relatively low interest rates can expect to experience capital outflows based on the actions of investors seeking to maximize income.

In a world of floating exchange rates, upward or downward changes in the spot rate can affect export and import transaction.The current level of spot exchange rates affects the relative cost of imports versus domestic goods.A high current level of the spot rate for a foreign currency discourages imports and encourages exports.A low exchange rate for a foreign currency encourages imports and discourages exports.

The future expected level of the spot rate may result in more complex balance of payments effects.Here expectations play an important role in affecting capital account as well as current transactions.