Balance of Payment and Exchange Rate Issues in British - Example

Discussion on Balance of Payment and Exchange Rate Issues in British University’s Name Submitted by Name Tutor: Date: Introduction There are a number of balance of payment (BOP) and exchange rate issues that affects the UK economy. The UK economy has not been fully stable since it experienced the financial crisis between 2008 and 2009. As a result, it has been experiencing an alarming BOP deficit and fluctuating exchange rate. The paper, therefore, focuses on the BOP and exchange rate issues affecting the UK economy and how the resolutions to those issues affect government funded charity organization that offers health and social services. Balance of Payment and Exchange Rate Issues in the UK Economy The UK has experienced a deteriorating balance of payment for the last few years, which has led to deficit in its BOP accounts (Springford and Tilford, 2013). At the same time, the country has been encountering in interpreting its BOP because of huge discrepancies that have emerged in its official estimations, especially between the deficit on current and long term accounts. However, the BOP deficit is not new in the UK economy because it has not been having any surplus since 1982. Therefore no one is worried about the large deficit and constant fluctuations in the BOP deficits. At the same time, the media, scholars and the general public pay less interest and attention to the status of the BOP in the British economy. Nevertheless, economists believe that the current status of the BOP deficit in the UK economy has entered danger zone and it is not sustainable because it is around 5% of the GDP (Springford and Tilford, 2013). The UK has encountered an alarming deterioration of its balance of payments. Between 2000 and 2010, the country had a foreign payment deficit of about £25 billion every year. The deficit increased to £62 billion and £73 billion in the year 2012 and 2013 respectively. Unfortunately, the foreign payment deficits in 2014 was estimated to be £90 billion, which is above the limit of 5% of the country’s GDP. Therefore, the account deficit is the main BOP issues that are facing the UK economy. Many economists and scholars have argued that the wide difference between the value of goods and services that the country export is the major cause of the huge BOP deficit that the country is experiencing today. For instance, in 2013, the country had a surplus of £78 billion on service while on goods it had a deficit of £110 billion on the same year (Coutts and Rowthorn, 2009). The UK net payment to other countries has also been increasing for the last few years, which has led to the deteriorating BOP in the country. It net payment to other countries was £10 billion in 2003 and it rose to £27 billion in 2013. Therefore, the UK the country is getting deeper and deeper in foreign debts pays its foreign payment deficit. The fall in sterling is also associated with the increasing BOP deficit because it led to lower export performance, as businesses used lower pounds to increase their margins. To significantly reduce the escalating deficit, the UK government must strive to match its foreign borrowing and lending. Therefore, the UK government must do all it can to arrest the ever increasing balance of payment deficit that the country is witnessing today. The primary solution that can be used to reduce the BOP deficit is to significantly enhance the net trade of the country, which is also directly influenced by the exchange rate (Coutts and Rowthorn, 2009). Therefore, the UK must strive to improve its international trade while at the same time watching the exchange rate. In addition, there are a number of policies that the government can use to reduce the balance of payment deficit that is negatively affecting the economy. First, it can use devaluation to reduce the value of its currency against other currencies in the global market. Devaluation makes importation expensive and exportation cheaper because it increases the price of imported good and reduces that of exported goods. However, the implementation of devaluation policy should be checked because it can lead to imported inflation. As a result, devaluation can lead to short term solution. The BOP deficit can also be reduced through deflationary policies like monetary and fiscal policies. The government can use the monetary policy to increase the interest rate and fiscal policy to increase income tax to reduce demand (Coutts and Rowthorn, 2009). Other possible solutions to the BOP deficits include lowering wages and protectionism. However, all the above solutions affect both consumers and traders in the UK economy. Therefore, they need careful implementation. Sterling depreciation is the major exchange rate issue that is affecting the UK economy. The UK’s exchange rate interest (ERI) depreciated by about 25% between 2007 and 2009. Unfortunately, it has remained flat since then and it is affecting the economic performance. However, exchange rate volatility is not new to the country because it started witnessing it in 1980s (Kara and Nelson, 2003). Like many economies around the world, the exchange rate volatility in the UK is caused by inflation, interest rate, and balance of payment. For instance, the low interest rate has led to the depreciation of the pound against other currencies because it makes the country less attractive to deposit money, which leads to less hot money flow. Other factors such as currency speculations and liberalization of the capital account have also contributed towards the exchange rate fluctuations in the UK economy. There has been a long term debate between the fixed and flexible exchange rate. There are different opinions in the type of exchange rate that should be used, especially when it is depreciating. However, according to Friedman, fixed exchange rate is dangerous to an economy and he advocates for flexible exchange rate (Friedman, 1953). According to Friedman, flexible exchange rate plays an important role in absorbing economic shocks. Therefore, UK can use the flexible exchange rate to deal with various economics shocks that end up affecting the stability of its currency. In order to solve the problem of depreciating interest rate, the UK, through its central bank should increase its interest rate, especially in short-term period (Kara and Nelson, 2003). The high interest rate makes domestic assets more attractive, which can help in strengthening the currency. However, the policy of increasing interest rate to stabilize exchange rate has been questioned by many people third party effects. The UK government can also intervene through foreign exchange market where it sells its international reserves. Therefore, the problem of exchange rate depreciation can be solved by increasing the interest rate and selling the international reserves. In addition, the government should also reduce the balance of payment deficit that also affects the exchange rate. Effects of BOP and Exchange Rate Resolutions on My Organization My organization is based in England and it does not engage in the international trade. It is a publicly funded charity that offers health and social services in England. Therefore, this part of the paper focuses on how alternative resolutions to BOP and exchange rate issues are affecting the health and social care system in England. Some of the solutions to the BOP and exchange rate issues include devaluation of currency, increasing interest rate, monetary policies, fiscal policies, lower wages, and protectionism policies. Monetary policies used to reduce the balance of trade benefits can negatively affect the operations of organization operating in the health and social system in UK. The British government is most likely to increase the interest rate to curb the soaring BOP deficit that affects its economic growth and development. However, high interest rate is most likely to lower the disposal income of consumers, as it increases the cost of debt and mortgages repayment (Lahiri, and Végh, 2000). As a result, it will cause a fall in aggregate demand, leading to poor economic growth and development. Consequently, the target consumers of the health and social services will find it hard to access such services due to their reduced income (Mulhearn and Vane, 2015). Despite the fact that the organization is fully funded by the government, the target clients must spend some money to access the services. The poor economic performance will also lead to a decline in government revenue, which means that the organization will not receive sufficient financial support from the government. Therefore, the operations of the organizations will be affected by an increase in interest rate to curb the BOP deficit (Lahiri, and Végh, 2000). However, the use of monetary policy may lead to hot money flow, which may end up causing appreciation in the exchange rate. As a result, the organization will be forced to lower spending on imported goods and services. Therefore, the overall effects of high interest rate to lower to stabilize the exchange rate and to reduce the balance of trade deficit are not clear. The use of fiscal policy such as the increase in income tax can also affect the organization. An increase in income tax will reduce consumer disposable income, which will end up decreasing their spending on health and social services. An increase in income tax will mean that less people will be seeking such services because they will be struggling to meet their basic needs. At the same time, it will lower the aggregate demand, leading to slow economic growth and high rate of unemployment (Mulhearn and Vane, 2015). Consequently, only a few people will be seeking health and social services offered by the organization. Besides, slow economic growth may force the government to significantly reduce its funding. As a result, the organization will to access adequate resources to finance it activities. However, despite the negative effects of fiscal policy on the operations of the organization, it also had positive impact that can improve the quality of its services. An increase in income tax will lead to an increase in government revenue. Therefore, the organization will receive enough funding from the government to boost its activities. Apart from improving the government finances, the fiscal policies will also not interfere with the exchange rate, which may lead to a stable economy. The protectionism policy to reduce the balance of payment deficit can also affect the operations of the organization. In order to execute protectionism, the government will impose tariffs and quotas on the imported goods, which may lead to an increase in government revenue. The UK government can use part of the revenue to finance the operations of the organization. At the same time, the revenue can be used in promoting other social and economic development. In addition, lowering wages to reduce the BOP deficit can negatively affect the operations of the organization (Mulhearn and Vane, 2015). First, low wages will reduce the disposable income of many people, which means that many people will resort to cheaper health and social services. As a result, more people will be seeking services from the organization since it offers charity services that are relatively cheaper. It can also lead to deflation and slow economic growth, which can affect the operations of the organization. The use of flexible exchange rate is also advantageous to the organization because it can be used to act shock absorber to various uncertainties that can affect the UK economy (Friedman, 1953). It will prevent the UK’s internal economy from external disturbing effects. Instead, it will promote economic growth and development. Consequently, the UK government will be in a better position to finance the activities of the charity organization. In addition, it also helps in eliminating the disequilibrium that may exists in the balance of payments, leading to a stable economy. However, it may have negative impact in the operations of the organizations because of its inflationary effects that can increase the price goods and services used by the organization (Friedman, 1953). Therefore, it causes frequent changes in prices of goods and services that can negatively affect budgeting and financial planning in the organization. Even though fixed exchange rate is not popular in the UK economy, it can help in reducing the uncertainties and risks that are associated with frequent changes in prices good and services. Conclusion Therefore, in summary, huge balance of payment deficit and depreciating exchange rate are some of the main issues facing the UK economy. The issues of BOP deficit and depreciating exchange rate have been with the country for relatively a long period of time. Even though the issues may be inevitable in the increased global economy, they should be reduced through rational and strategic economic interventions, especially through the use of fiscal and monetary policies. However, the resolutions to the issues are more likely to affect other sectors of the economy like organizations in the health and social system. The resolutions affect government revenue, the aggregate demand, prices of goods and services, employment, and the general economic growth and development. Reference List Coutts, K.J. and Rowthorn, B., 2009. Prospects for the UK Balance of Payments. Centre for Business Research, University of Cambridge. Friedman, M., 1953. The case for flexible exchange rates. Kara, A. and Nelson, E., 2003. The exchange rate and inflation in the UK. Scottish Journal of Political Economy, 50(5), pp.585-608. Lahiri, A. and Végh, C., 2000, December. Fighting currency depreciation: intervention or higher interest rates. In NBER Conference on Currency Crises. Mulhearn, C. and Vane, H., 2015. Economics for Business. Palgrave Macmillan. Springford, J. and Tilford, S., 2013. The Great British trade-off. Financial Times. Read More