4.1.7 Balance Of Payments

Question 1

4.1.7a
Define Balance of Payments

Answer 1

Record of a country’s flows of money with the rest of the world

Question 2

4.1.7a
Components of Balance of Payments

Answer 2

• the current account
• Capital + financial account

Question 3

4.1.7a
Current Account

Answer 3

Trade of
- goods + services
- income flows (profits , interest etc)
- current transfers (remittances , aid etc)

Question 4

4.1.7a
Capital and Financial Account

Answer 4

Capital:
- unimportant
- emigrants / immigrants taking/brining money into the country

Financial:
- FDI (>10%)
- Portfolio (<10%)
- other (loans / purchasing currency)

Question 5

4.1.7b
Causes of a current account deficit

Answer 5

• ↑ Domestic inflation > trading partners → ↓ price competitiveness → ↓ exports + ↑ imports → trade deficit
• ↑ Consumer income/confidence → ↑ demand for imports → ↑ import bill → current account deficit
• ↑ Exchange rate (appreciation) → ↑ export prices + ↓ import prices → ↓ export demand + ↑ imports → worsens trade balance
• ↓ Productivity → ↑ unit labour costs → ↓ export competitiveness → ↓ export revenue → current account deficit

Question 6

4.1.7b
Causes of Current account surplus

Answer 6

• ↑ Productivity in export sectors → ↓ costs of production → ↑ competitiveness → ↑ export volumes → trade surplus
• Domestic recession → ↓ income + consumption → ↓ import demand → improves current account
• ↓ Exchange rate (depreciation) → ↓ export prices + ↑ import prices → ↑ exports + ↓ imports → trade surplus
• ↑ Savings ratio → ↓ consumer spending → ↓ imports → improves trade balance

Question 7

4.1.7c
Measures to reduce current account imbalance

Answer 7

• Expenditure switching policies
• Expenditure reducing policies
• Supply Side Policies

Question 8

4.1.7c
Expenditure- switching policies

Answer 8

• ↓ Exchange rate (via devaluation or depreciation) → ↓ export prices + ↑ import prices → ↑ exports + ↓ imports → improves current account
• ↑ Tariffs/quotas on imports → ↑ price of foreign goods → ↓ import demand → narrows trade deficit
• Buy British campaigns → ↑ demand for domestic products → ↓ demand for imports → helps correct deficit

Question 9

4.1.7c
Expenditure- reducing policies

Answer 9

• ↑ Interest rates → ↓ consumption + ↓ borrowing → ↓ demand for imports → improves current account
• ↑ Taxes or ↓ government spending → ↓ disposable income → ↓ import consumption → trade deficit falls

Question 10

4.1.7c
Supply side policies

Answer 10

• ↑ Investment in education/skills → ↑ productivity → ↓ unit costs → ↑ competitiveness → ↑ exports → narrows deficit
• Subsidies for exporting firms → ↓ production costs → ↑ export supply → ↑ export earnings → improves trade balance

Question 11

4.1.7d
Significance of trade imbalances

Answer 11

• Persistent current account deficits in some countries → ↑ foreign borrowing → ↑ debt vulnerability → ↓ investor confidence
• Persistent surpluses in other countries → ↓ global demand (due to low spending) → ↑ global savings glut → ↑ deflationary pressures worldwide
• Imbalances between major economies → ↑ exchange rate volatility → ↑ risk of protectionism → ↓ global trade growth
• Global imbalances → unsustainable capital flows → ↑ risk of financial crises if investors pull out suddenly → ↑ economic instability