4.1.7 - Balance Of Payments

Question 1

What Is The Balance Of Payments?
(4 Points)

Answer 1

~ Record of all financial transactions that occur between it and the rest of the world.

~ Has to balance. E.g. If there is a current account deficit, there must be a financial and capital account surplus. Vice versa.

~ Money flowing into a country is a credit (+).

~ Money flowing out of a country is a debit (-).

Question 2

What Are The 2 Components Of The Balance Of Payments?

Answer 2

~ Current account.

~ Financial and capital account.

Question 3

Describe The Current Account
(3 Points)

Answer 3

~ Measures trade in GOODS and SERVICES via imports and exports. (Trade balance)

~ Measures INVESTMENT INCOME. (Income balance) E.g. Remittances -> Uk worker goes abroad and works there, bringing the income back will be a credit in the current account.

~ Measures CURRENT TRANSFERS -> Government level spending between countries. (Income balance) E.g. Aid to developing countries.

Question 4

What Is Meant By A Current Account ‘Deficit’
(4 Points)

Answer 4

~ Buying more from the rest of the world, then it’s selling to the rest of the world.

~ More money leaving the country, than entering through financial transactions.

~ Cannot be sustained in the LR.

~ Money to fund this tends to come from surpluses in the financial account.

Question 5

What Is Meant By A Current Account ‘Surplus’
(4 Points)

Answer 5

~ Selling more to the rest of the world, than its buying from the rest of the world.

~ More money entering the country, then leaving through financial transactions.

~ Sitting on a lot of excess cash, investing it into countries where there is a current account deficit.

~ Meaning this country will have a financial account deficit.

Question 6

Describe The Capital & Financial Account
(2 Points)

Answer 6

~ Capital = Measures small capital flows.

~ Financial = Records countries cross-border transactions. E.g. FDI, portfolio investment.

Question 7

What Are Causes Of A Current Account Deficit On The Demand Side?
(3 Points)

Answer 7

~ Strong domestic growth.

~ Recession overseas.

~ Strong exchange Rates.

Question 8

What Are The Consequences Of A Current Account Deficit?
(2 Points)

Answer 8

~ Lower AD, due to net exports decreasing -> causes decrease in growth and rising unemployment.

~ Debt burdens, due to borrowing from other countries to finance the deficit -> causes investors losing confidence.

Question 9

What Are Causes Of A Current Account Surplus On The Demand Side?
(3 Points)

Answer 9

~ High incomes abroad, increasing demand for exports.

~ Low incomes at home, reduce demand for imports.

~ Weak exchange rate, WIDEC.

Question 10

What Are The Consequences Of A Current Account Surplus?
(2 Points)

Answer 10

~ AD can increase.

~ Growth increases.

Question 11

What Are Measures To Reduce Imbalances On The Current Account?
(3 Points)

Answer 11

~ Expenditure reducing policies.

~ Expenditure switching policies.

~ Supply-side policies.

Question 12

Describe Expenditure Reducing Policies
(3 Points)

Answer 12

~ Reduces the amount of spending on imports.

~ Work by reducing AD and incomes and the MPM.

~ Contractionary monetary and fiscal policies can be used.

Question 13

What Are The Consequences of Using Expenditure Reducing Policies?

Answer 13

Conflicts of macro objectives -> growth reduces, unemployment increases.

Question 14

Describe Expenditure Switching Policies
(3 Points)

Answer 14

~ Using protectionist policies, to reduce domestic spending on imports of certain items.

~ Or using a weaker exchange rate, WPIDEC.

~ Used to switch spending towards domestic goods and services.

Question 15

What Are The Consequences of Using Expenditure Switching Policies?
(3 Points)

Answer 15

~ Retaliation, can worsen current account further.

~ Can break WTO rules, leads to heavy fines.

~ Can be inflationary, increasing the price of exports.

Question 16

How Do Supply Side Policies Work, To Reduce Imbalances On The Current Account

Answer 16

Boost international competitiveness of a countries exports.