ABSTRACT
INTRODUCTION: WHEN IS THE BALANCE OF PAYMENTS A PROBLEM? International trade is a large-scale example of the standard gains from voluntary exchange which are central to market transactions. The exchange and trade pattern between nations results from differences in their comparative advantages as reflected in costs, prices and qualities of goods and services. Trade takes place at a set of prices and the resulting payments and receipts for the purchase and sale of goods and services in world markets is reflected in the current account of Britain’s balance of payments. In addition, the private and public sectors in the UK and overseas buy and sell short-and long-term real and financial assets and whether the UK is a net creditor or debtor on such transactions is shown in the capital account of the balance of payments. Ex ante, a nation’s planned expenditures and receipts will not necessarily balance. If Britain’s foreign expenditures on goods, services and assets exceeds its receipts, there will be a deficit or net outflow of payments to foreigners. This will be financed by a reduction in the UK’s foreign exchange reserves and by short-term borrowing so that, ex post, the balance of payments as an accounting identity will always balance. For simplicity, this chapter will concentrate on the current account.
