Balance of Payments of Current Account / Exchange Rates

Question 1

Definition of Current Account Deficit

Answer 1

Where Imports are greater than exports

• X

Question 2

Definition of Current Account Surplus

Answer 2

Where Exports are greater than imports

• X > M

Question 3

What are the components of the Current Account

Answer 3

• Trade in Goods
• Trade in Services
• Investment Income
• Transfers

Question 4

Factors which cause a Current Account Deficit

Answer 4

• Overvalued Exchange Rate (Appreciation) - if the currency is appreciating, imports will become cheaper and therefore there will be a higher quantity of imports.
• Economic Growth - If there is an increase in AD and National Income increases, people will have more disposable income to consume goods.
• Decline in Competitiveness - If there is hight inflation or a decline in productivity there will be less demand for UK exports.

Question 5

How is a Current Account Deficit financed

Answer 5

• Increase level of borrowing

* Net run down in savings

Question 6

Demand Policies to reduce a Current Account Deficit

Answer 6

• Devaluation - this is lowering the value of the currency agains others, making exports cheaper and imports more expensive.
- However, this can lead to imported inflation

• Reduce Consumer spending - Govt. raises interest rates or increases taxes then people will have less money to spend.
- However this policy will conflict with the macroeconomic objectives with lower AD, growth is likely to fall causing unemployment.

Question 7

Factors which influence the Exchange Rate

Answer 7

• Relative Inflation Rates - If inflation in the UK is lower than elsewhere, then the UK exports will become more competitive - Appreciation.
• Relative Interest Rates - If UK interest ratees rise relative to elsewhere it will become more attractive to deposit money in the UK, thus the demand for the sterling will rise. This is known as HOT MONEY FLOWS.
• Speculation -
• Strong Economy - If the UK economy is growing rapidly then interest rates are likely to rise to keep inflation low.
• Current Account

Question 8

Economic Effects of a Depreciation of the currency

Answer 8

• Imports will become more expensive
• Inflation as AD increases
• Exports more competitive

Question 9

Definition of a Depreciation

Answer 9

Where Exports are cheaper and Imports are more expensive

Question 10

Definition of an Appreciation

Answer 10

Where Exports are more expensive and Imports are cheaper

Question 11

Economic Effects of an Appreciation of the currency

Answer 11

• Exports are more expensive
• Imports are cheaper
• A fall in AD, causing lower growth
• Lower inflation