4.1 Balance of Payments

Question 1

What is the balance of payments?

Answer 1

A record of all international financial transactions made by the residents of a country and the rest of the world

Question 2

What is the current account?

Answer 2

A record of the value of the net flow of goods/services and income (primary and secondary)

Question 3

What are the 2 sections of a balance of payments?

Answer 3

• Current account
• Financial account + Capital account

Question 4

What is the financial account?

Answer 4

Transactions that result in a change of ownership of financial assets/liabilities between a country’s residents and non-residents

Question 5

What is a current account deficit?

Answer 5

When the total value of goods/services a country imports exceeds the total value it exports

Question 6

What is a current account surplus?

Answer 6

When an economy is exporting a greater value of goods and services than it is importing

Question 7

What are the 3 short-term causes of a current account deficit?

Answer 7

- High levels of consumer demand/income (meet this demand by importing)
- Strong exchange rate (reduces the price of imports, increases the price of exports)
- High inflation (increases the price of exports for other countries)

Question 8

What are the 3 transactions involved in a balance of payments?

Answer 8

• Trade flows
• Investment incomes
• Other financial transactions

Question 9

How are the current account and financial account interdependent?

Answer 9

• CA Deficit matched with FA surplus
• CA Surplus matched with FA Deficit

(a country needs/has excess foreign exchange reserves, represented by an inflow or outflow of foreign money)

Question 10

Why must a current account surplus be matched by a financial account deficit?

Answer 10

When a country exports more, it earns more foreign exchange from exports than is used for imports (accumulating foreign exchange reserves)

Question 11

What are 3 examples of primary income?

Answer 11

• Profits
• Dividends
• Interest payments

Question 12

What are 2 examples of secondary income?

Answer 12

• Remittances
• Foreign aid

Question 13

What are the 3 causes of a current account surplus?

Answer 13

- Low exchange rate (increases the price of imports, decreases the price of exports)
- Low imports/high savings rate (less domestic spending)
- Low inflation

Question 14

What are 2 disadvantages of a current account deficit?

Answer 14

• Unemployment (domestic job losses as fewer goods produced)
• Poor economic growth (uncompetitive, overreliance on foreign imports, low AD)

Question 15

What is an advantage of a current account deficit?

Answer 15

• Higher levels of domestic consumption (can improve standard of living/inequality)

Question 16

What are the 4 components of a current account?

Answer 16

• Net balance of trade in goods
• Net balance of trade in services
• Net primary income
• Net secondary income

Question 17

What are the 3 components of a financial account?

Answer 17

• Net balance of FDI
• Net balance of portfolio investment (flows of debt/equity)
• Balance of banking flows

Question 18

What are 3 long-term causes of a current account deficit?

Answer 18

- Deindustrilisation (decrease in manufacturing means it is difficult to export)
- Lack of capital investment (domestic firms have lower productivity)
- Natural resources (countries with natural resources tend to export more)

Question 19

Evaluation for a current account deficit

Answer 19

• May occur due to high growth/strong consumer spending, rather than uncompetitiveness
• Deficit financed by long-term capital investment may be more sustainable than by borrowing

Question 20

What are the 4 policies used to reduce imbalances in the balance of payments?

Answer 20

• Do nothing (allow market forced to self-correct deficit)
• Expenditure switching policies
• Expenditure reducing policies
• Supply-side policies

Question 21

What is the difference between an expenditure switching and reducing policy?

Answer 21

- Expenditure switching policy: aims to switch consumer spending towards domestic goods, away from imports
- Expenditure reducing policy: aims to reduce consumer demand in an economy

Question 22

What are 2 examples of expenditure switching policies?

Answer 22

• Depreciation/devaluation
• Protectionism (tariffs/quotas)

Question 23

What are 2 examples of expenditure reducing policies to correct a CA deficit?

Answer 23

• Contractionary fiscal policy
• Contractionary monetary policy

Question 24

What are 3 examples of supply-side policies to correct a CA deficit?

Answer 24

• Deregulation
• Cutting business taxes
• Investment in education/training (interventionist)

Question 25

How does a depreciation help to correct a current account deficit to correct a CA deficit?

Answer 25

- Government may allow the currency to depreciate - This encourages exports (which become cheaper) - This discourages imports (which become expensive) - However can result in higher domestic inflation

Question 26

How is a CA deficit balanced by the financial account?

Answer 26

The excess spending on imports (CA deficit) has to be financed from an inflow of money into the country from the sale of assets (FA surplus)

Question 27

What is the reason for a global trade imbalance?

Answer 27

- Global trade: net sum of trade (I + E) across different countries - if one country is running a current account surplus then another country is running a deficit

Question 28

Why are persistent deficits problematic?

Answer 28

It means that finance from abroad (e.g loans or FDI) are required to fund continued imports

Question 29

Why is a persistent surplus problematic?

Answer 29

The focus of the allocation of resources is on meeting foreign demand rather than meeting domestic demand

Question 30

What are 2 drawbacks of a persistent deficit?

Answer 30

- A country is gradually selling its assets - Increases vulnerabilities (a country owes money to foreign entities)

Question 31

What are 2 drawbacks of a persistent surplus?

Answer 31

- Can limit availability of goods/services in the local economy (lowers standard of living) - Can create instability in the foreign exchange market (if exchange rate is floating)

Question 32

What was the UK's current account deficit in 2024?

Answer 32

£76 billion (2.7% of GDP)

Question 33

EVAL for current account deficit

Answer 33

- Depends on cause of current account deficit (supply-side or demand-side) - If deficit caused by weak productivity growth instead of high AD, may be more concerning/persistent