Balance Of payments

Question 1

Balance of payments

Answer 1

The record of all money flows or transactions between the residents of a country and the rest of the worlds economy’s in a period of time

Question 2

Current account

Answer 2

Measures the currency flows into and out of the country including trade income, FoP, primary and secondary income.

Question 3

Why might the current account be the most important part of the BOP

Answer 3

Reflects the economy’s international competitiveness and the extent the country is living within its means

Question 4

Primary income flows

Answer 4

Net income flows made up of investment generated from profit dividends and shares
Flowing between countries

Question 5

Example of primary net income

Answer 5

Japan Nissan investment into Sunderland UK

Question 6

Secondary income flows

Answer 6

Current transfers e.g aid charity overseas
E.g. UK contribution to the EU budget pre brexit

Question 7

Financial account

Answer 7

Part of the BOP which records capital flows in and out of the economy including net fdi, net portfolio investment and short term speculative capital

Question 8

Foreign direct investment

Answer 8

Investment in capital assets such as manufacturing
E.g. Japan nissanninto UK 1980s and 90s

Question 9

Short term capital flows

Answer 9

“Hot money”
Largely speculative
Quick speculative profits can be made by moving between appreciating currencies
Also by high interest rates

Question 10

Expenditure reducing policy

Answer 10

A government policy which aims to eliminate the current account decide by reducing the demand for imports and reducing AD

Question 11

Expenditure switching policy

Answer 11

A government policy which aims to eliminate the current account deficit by switching domestic demand away from imports to domestically produced imports

Question 12

Three main policies to reduce deficit caused by an overvalued exchange rate

Answer 12

Expenditure reducing - Deflation - contraction are monetary or fiscal policy

Expenditure switching-
Direct controls - imports quotas tariffs
Devaluation - lowering the exchange rate

Question 13

What does deflation (expenditure reducing) involve

Answer 13

Using contractionary monetary or fiscal policy
Reducing the domestic price inflation relative to IR deflation improved the price competitiveness of exports and reduces that of imports

Question 14

Criticism of deflation (expenditure reducing policy)

Answer 14

Small impact
Output, income and employment falls rather than the price level
Government sacrifice the domestic economic objectives of full employment and economic growth

Question 15

Benefits of expenditure reducing deflation

Answer 15

When the economy is overheating it can control domestic inflationary pressures as well as correct a BoP deficit

Question 16

What does direct controls include

Answer 16

Quotas or embargoes
Directly cutting expenditure
However does not cure the underlying cause (uncompotitiveness of a country’s goods)
Protectionism reduces specialisation and world trade/oupit/welfare to fall

Question 17

Why is the UK unlikely to use direct controls

Answer 17

Member of the WTO and the EU

Question 18

Devaluation effect of elastic demand for exports and imports

Answer 18

Likely to result in a reduction in the current account deficit

exports appear cheaper to foreigners

imports become more expensive as a lower exchange rate means more currency is needed to buy the same amount of foreign currency leadinig to a lower quanitity of imports

Question 19

Factors determining a current account balance

Answer 19

1.labour productivity/output (price and quality competitiveness and success of SSPs)
2.inflation relative to competing nations
3.exchange rate - rising er increases foreign currency prices and reduces competitiveness

Question 20

Short run deficit benefit

Answer 20

Living standards may increase

Question 21

Long run deficit negatives

Answer 21

Decline of industries competitiveness and lower living standards

Question 22

negatives of devaluation (expenditure switching)

Answer 22

makes imports more expensive for domestic consumers
depends on PED for X and M, which needs to be elastic to ensure demand for X rises and M falls
if PED elastic for both then will not lead to significant enough changes

Question 23

marshall learner conditition

Answer 23

states that devaluation will improve CA only if PED for X and M together is greater than 1

Question 24

J curve

Answer 24

demand becomes more elastic overtime
more substitutes become available

X prices fall but this wont lead to higher X prices immediately
only if higher elasticity of demand

M more expensive than X after devaluation, but D will not fall much in short term as inelastic (more is spent on M until X becomes more elastic)

Question 25

J curve impacts on CA in short and long term

Answer 25

short - worsens further into a deficit
long term - slowly improves as D more elastic

Question 26

protectionist policies

Answer 26

expenditure switching) trade barriers should reduce Q of M and encourage a switch to domestically produces goods and balance the CA

Question 27

issues with protectionist expenditure switching policies

Answer 27

may provoke realiation with similiar measures which may lower X and CA doesnt improve
tariffs to restrict M assumes demand is price elastic and their are available substitutes

Question 28

supply side policies to balance CA

Answer 28

improvemeents in productivity and keeping inflation low to boost competitiveness of UK exports
spending on M may fall

Question 29

issues with SSPs to balance CA

Answer 29

expensive to implement - opp cost
time lag

Question 30

capital account

Answer 30

a record of the inflows and outflows of capital that directly affect a nation’s foreign assets and liabilities

Question 31

structure/three components of current account

Answer 31

trade balance
primary income balance
net income balance

Question 32

current account balanced by financial account example

Answer 32

US will purchase goods from china and run a current account deficit
china wil use foreign currency to buy US bonds and run a financial account surplus

Question 33

current account deficit

Answer 33

value of imports > value of exports

Question 34

current account surplus

Answer 34

value of exports > value of exports

Question 35

3 factors influencing CA

Answer 35

productivity
exchange rates
inflation

Question 36

how does productivity impact CA balance

Answer 36

higher productivity levels will produce more output allowing a country to export more goods
higher productivity also improves competititivess which drives down prices, leading to more overseas consumption

Question 37

how does ER impact CA balance

Answer 37

may impact value of exports - stronger pound will make imports cheaper and therefor lead to a CA deficit

weaker currency may encourage remittances and decrease outflows which improves the balance

capital inflows may appreciate the currency

rising CA deficit leads to an increasing supply of currency in FOREX market

Question 38

how do inflation rates influence CA balance

Answer 38

increase in inflation yields an increase on foreign assets (liabilities) and effects the net FDI that composes the CA

increasing IR decreases consumer spending causes imports to fall

higher IR reduces inflation making goods more competitive and improves CA

higher IR = hot money flows = appreciation of ER (spiced) worsens CA