Commercial Bank & Central Bank

Functions of Commercial Banks:

PRIMARY FUNCTIONS: There are TWO types of primary function of Commercial Banks:

·       Accepting Deposits:  Commercial Banks accepts deposits from their customers in different forms of Accounts, Like Savings A/C, Current A/C, Recurring A/C etc.

·       Granting Loans: Commercial Banks grants loan to individuals, business, firms etc for different purpose. Like they provides Industrial Loan, Housing Loan, Personal Loan, Education Loan, Car Loan etc.

SECONDARY FUNCTIONS: They perform following secondary functions:

·       Exchange of foreign currency.

·       Provides safe deposit lockers.

·       Provide insurance policies.

·       Pay different types of bills for customers.

·       They provide credit and debit card facility.

·       They provide on-line banking and transfer of money.

·       Provides financial advice to the customers.

·       Buying and selling of shares.

Central Banks

Central Banks are charged with regulating the size of a nation’s money supply, the availability and cost of credit, and the foreign-exchange value of its currency. Regulation of the availability and cost of credit may be designed to influence the distribution of credit among competing uses. The principal objectives of a modern central bank in carrying out these functions are to maintain monetary and credit conditions conducive to a high level of employment and production, a reasonably stable level of domestic prices, and an adequate level of international reserves.

Function of a Central Bank

A central bank usually carries out the following responsibilities:

1. ·         Implementation of monetary policy.
2. ·         Controls the nation's entire money supply.
3. ·         The Government's banker and the bankers' bank ("Lender of Last Resort").
4. ·         Manages the country's foreign exchange and gold reserves and the Government's stock register;
5. ·         Regulation and supervision of the banking industry
6. ·         Setting the official interest rates- used to manage both inflation and the country's exchange rate - and ensuring that this rate takes effect via a variety of policy mechanisms
7.  

NEWS ARTICLES for IBDP Economics

1. IB ECONOMICS: Supply and Demand -Oil Prices -

http://www.economist.com/news/finance/21678198-once-prices-are-responding-supply-and-demand-not-opec-why-market

2. Oil Prices: What’s Behind the Volatility? Simple Economics

https://www.nytimes.com/interactive/2016/business/energy-environment/oil-prices.html?_r=1

3. IB Economics: Monetary Policy, reduced interest rates stimulate the economy

http://www.bbc.com/news/business-35770370

4. IB Economics: What is quantitative easing?

http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5

BALANCE OF PAYMENT

BALANCE OF PAYMENT

Balance of Payments- Worksheet

1. Distinguish between an import and an export

2. Visible and invisible trade

3. State whether the following are

i)               an export or an import for Hong Kong

ii)             visible trade or invisible trade

Transaction	Current/Capital/Financial	Credit/debit
A US company buying shares on the HK stock market
HK citizen sending wages earned in UK back to HK
A HK company selling prawns direct to France
An Italian firm investing in a chain of restaurants
HK company paying dividends to US shareholder

   
4. In which part of the HK Balance of Payments account would the following transactions be recorded & state if they credit or debit items

Transaction	Current/Capital/Financial	Credit/debit
A US company buying shares on the HK stock market
HK citizen sending wages earned in UK back to HK
A HK company selling prawns direct to France
An Italian firm investing in a chain of restaurants
HK company paying dividends to US shareholder

5. The fictitious figures below refer to the HK’s balance of payments for 2007, 08, 09 and 2010 Calculate for each year     

a) Balance on trade in goods

                                                b) Balance on trade in services

                                          c) The balance of trade

                                          d) The current account balance

Year	Goods exported	Goods imported	Services exported	Services imported	Net Income Flows	Net current transfers
2007	42,345	57,600	654,000	124,000	-12,500	-34,000
2008	123,000	245,786	12,789	9,876	123,765	47,987
2009	56,363	66,666	46,879	38,945	100,000	-99,999
2010	853,970	900,000	345,876	200,000	0	34,987

Factors which cause a current account Deficit in the balance of Payments

Fixed Exchange Rate

If the currency is overvalued, imports will be cheaper and therefore there will be a higher Q of imports. Exports will become uncompetitive and therefore there will be a fall in the Quantity of exports.

Economic Growth

If there is an increase in AD and National Income increases, people will have more disposable income to consume goods. If domestic producers can not meet the domestic AD, consumers will have to imports goods from abroad. Therefore if there is fast economic growth there tends to be a big increase in imports.

Decline in Competitiveness.

IN the UK there has been a decline in the exporting manufacturing sector, because it has struggled to compete with developing countries in the far east. This has led to a persistent deficit in the balance of trade.

Higher inflation

This makes exports less competitive and imports more competitive. However this factor may be offset by a decline in the value of sterling.

Recession in other countries.

If  the UK’s main trading partners experience negative economic growth then they will buy less of our exports, worsening the current account.

Borrowing money

If countries are borrowing money to invest e.g third world countries

Deterioration in the current account

            This means that the value of exports has increased at a slower rate than the value of imports. Therefore there could have been an increase in the deficit or the surplus could have changed into a deficit.

Current Account Deficit

If there is a current account deficit, then imports tend to exceed exports, this means that the supply of the currency has risen as people have bought fewer products in that country’s currency. This then causes a downward pressure on the exchange rate and the relative value of the currency to fall, depreciation. 

Implications of a persistent current account deficit

·       Exchange rates: the currency should automatically depreciate, which will then help to rectify the deficit as exports become cheaper relative to imports.

·       Interest rates: the central bank may decide to increase these in order to encourage foreign direct investment, however, this may reduce domestic investment and consumption as there is a greater incentive to save than spend which could lead to lower levels of growth.

·       Indebtedness: if the country is having to borrow in order to finance the current account deficit then they may accumulate so much debt that they are unable to pay it back and so default. This undermines confidence in the economy, so they may be unable to get any future loans. 

·       International credit ratings: a persistent current account deficit may cause the international credit rating agencies to lower their rating which may lead to even lower expectations about the economy’s future.

·       Demand management: in order to rebalance the account deficit they make take measure to reduce demand which can be very painful for the economy as a whole. 

Current Account Surplus

If there is a current account surplus, then exports tend to exceed imports, this means that the demand for the currency has risen as people have bought products in that country’s currency. This then causes an upward pressure on the exchange rate and the relative value of the currency to rise, appreciation. 

Implications of a persistent current account surplus

·       Appreciation: as exports increase, the demand for the currency increases and therefore the value of the currency increases.

·       Reduced export competitiveness: as the currency appreciates, in a floating exchange rate, exports become comparatively more expensive so demand for exports fall.

·       Lower domestic consumption and investment: as the currency appreciates, imports will become more affordable compared to domestic products so consumption of domestic products falls. The appreciation can also deter foreign investment from abroad as it becomes more expensive. 

Is a Current Account Deficit a bad Thing?

Why a Current account is considered harmful to the economy

1.     A current account deficit is financed through borrowing or foreign investment. So the country’s debt will increase.

2.     Borrowing is unsustainable in the long term and countries will be burdened with high interest payments. E.g Russia was unable to pay its foreign debt back in 1998. Other developing countries have experience similar repayment problems Brazil, African. (3rd World debt)

3.     Foreigners have an increasing claim on UK assets, which they could desire to be returned at any time. It means FDI will decrease. E.g. a severe financial crisis in Japan may cause them to repatriate their investments

4.     Export sector may be better at creating jobs. So, the employment opportunity in domestic sector will decrease. 

5.     A Balance of Payments deficit may cause a loss of confidence in the economy.

However a current account deficit is not necessarily harmful

1.     Current Account deficit could be used to finance investment.

E.g. US ran a Current account deficit for a long time as it borrowed to invest in its economy. This enabled higher growth and so it was able to pay its debts back and countries had  confidence in lending the US money.

2.     Japanese investment has been good for UK economy not only did the economy benefit from increased investment but the Japanese firms also helped bring new working practices in which increased labour productivity.

3.     With a floating exchange rate a large current account deficit should cause a devaluation which will help reduce the level of the deficit

It depend on the size of the budget deficit as a % of GDP, for example the US trade deficit has nearly reached 5% of GDP (02/03) at this level it is concerning economists

Methods to resolve a current account deficit

Expenditure switching policies:

This policies aims at encouraging people to switch their spending on imports to domestic goods. These may include: 

·       Devaluing the exchange rate,

·       Tariffs

·       Quota

·       Embargo &

·       Polices to reduce inflation.

The aim is to reduce the demand and supply of imports, rather than reducing overall consumption.

Expenditure reducing policies:

These policies aim to reduce the real spending of consumers. Such policies include fiscal and monetary polices.

·       Contractionary Fiscal Policy &

·       Contractionary Monetary Policy

For instance, the government may increase taxes and reduce spending, whilst the central bank may increase interest rates to incentivise saving.

Supply-side policies:

Policies may be needed in order to improve the country’s productivity in order to improve its exports competitiveness in the international markets. These policies including lowering production costs by reducing the minimum wage, trade union power, business taxes and implementing deregulation.