6.3 The Balance Of Payments Flashcards
(47 cards)
1
Q
Define balance of payments
A
- a record of all financial transactions made between consumers, firms and the government from one country with other countries.
- It states how much is spent on imports, and what the value of exports is.
2
Q
Define exports
A
- goods and services sold to foreign countries
- positive in the balance of payments.
- they are an inflow of money.
3
Q
Define imports
A
- goods and services bought from foreign countries
- negative on the balance of payments
- they are an outflow of money.
4
Q
What is the balance of payments made up of?
A
- The current account
- The capital account
- The financial account
- Balancing item
5
Q
Define current account
A
- includes all economic transactions between countries.
6
Q
What are the 4 sections of the current account?
TTPS
A
- trade in goods
- trade in services
- primary income
- secondary income
7
Q
What is meant by the trade balance?
A
- trade in goods + trade in services
- exports - imports
8
Q
What is meant by the income balance?
A
- primary income + secondary income
9
Q
Give two examples of primary income
A
- income from interest
- income from shares and profits
10
Q
Give two examples of secondary income?
A
- EU payment
- Repatriation of wages
- Aid and grants
11
Q
Define capital account
A
- involve transfers of the ownership of fixed assets.
12
Q
What are the three sections of the capital account?
DID
A
- debt forgiveness
- inheritance tax
- death duties
13
Q
Define financial account and give its two sections
A
- The financial account involves investment.
- For example, direct investment, portfolio investment and reserve assets are part of the financial account.
14
Q
Give three examples of portfolio investment
CGH
A
- corporate shares and bonds
- government bonds
- hot money
15
Q
Define balancing item/ What is the sum of the current account, the financial account, and the capital account?
A
- The components of the Balance of Payments should balance.
- the sum of the accounts is 0
- Where there are imbalances, a balancing item is used to cover the discrepancies.
16
Q
What is the Marshall Lerner condition?
A
- states that a depreciation/devaluation of a currency will eventually lead to a net improvement in the trade balance on the BoP if the PEDx + PEDm > 1
17
Q
What is a current account surplus?
A
- means there is a net inflow of money into the circular flow of income.
- The UK has a surplus with services, but a deficit with goods.
18
Q
What are the two types of causes of current account surpluses?
A
- structural
- cyclical
19
Q
List 3 causes of a structural current account surplus
A
- significant long-run comparative advantage
- trend rise in factor productivity
- long-run rise in global prices of main exports
- surplus of savings over investment
- structural increase in net investment income
20
Q
List 3 causes of a cyclical current account surplus
A
- depreciation of the exchange rate
- strong consumer demand in key export markets
- fall in prices of imported energy / FoP
21
Q
What is a current account deficit?
A
- UK has a net current account deficit.
- This means the UK spends more on imports from foreign countries, than they earn from exports to foreign countries.
- If the deficit is large and runs for a long time, there could be financial difficulties with financing the deficit
22
Q
What is meant by a cyclical trade deficit?
A
- one that occurs as a result of the trade cycle being in the growth/boom phase
23
Q
What is meant by a structural trade deficit?
A
- long term in nature
- occurs due to an underlying lack of productivity and international competitiveness in the economy
24
Q
What are the causes of balance of payments disequilibrium?
Appreciate Everything My Dear Miss Angel
A
- Appreciation of the currency:
-a stronger currency means imports are cheaper and exports are relatively more expensive (SPICED) which means the current account deficit would worsen. - Economic growth:
-when consumer incomes increase, demand increases.
-this could increase demand for imports.
-this is especially true of a country such as the UK, where consumers have a high propensity to import. - More competitive:
-if a country becomes more internationally competitive, such as with lower inflation or if there is economic growth in export markets, exports should increase.
-also occurs when a country becomes more productive, since that causes average unit costs to fall.
-could cause the current account deficit to improve, or increase the current account surplus. - Deindustrialisation:
-In the UK, the manufacturing sector has been declining since the 1970s.
-The goods that the UK previously made domestically now have to be imported, which worsens the deficit. - Membership of trade union:
-The UK has traditionally had negative current transfers, since fees are paid for membership of the EU. - Attractiveness to foreign investors:
-A capital account surplus could be caused by incoming finance from investors buying UK bonds, securities and financial derivatives.
-This could help fund a current account deficit.
25
What occurs when there is a current account surplus?
- there is a capital and financial account deficit.
26
What occurs when there is a current account deficit?
- there will be a capital and financial account surplus.
27
What happens if the UK sells more exports to foreign countries?
- the UK will have a greater inflow of money into the circular flow of income.
- This will increase AD and improve the rate of economic growth.
28
What happens to the UKs current account deficit during recessions?
- the current account deficit falls.
- this is because consumer spending falls.
29
What is the impact of higher incomes on the currency account during periods of economic growth?
- During periods of economic growth, when consumers have higher incomes and they can afford to consume more
- there is a larger deficit on the current account.
30
What is the impact of raw materials?
- If imported raw materials are expensive, there could be cost-push inflation in the UK, since firms face higher production costs.
31
What happens to imports and exports when the pound appreciates?
| Acronym-SPICED
- imports become relatively cheaper and exports become more expensive
32
What happens to the UK economy if it becomes more productive?
- the UK will be more internationally competitive.
- this causes exports to increase relative to imports.
33
What is Foreign Direct Investment?
- the flow of capital from one country to another, in order to gain a lasting interest in an enterprise in the foreign country.
34
What are the consequences of investment flows between countries?
- FDI can help:
-create employment opportunities
-encourage innovation of technology
-help promote long term sustainable growth.
- Provides LEDCs with funds to invest and develop.
- Portfolio investments are passive, control over the company is not gained.
-The investment aims to make a financial gain.
- FDI, on the other hand, allows the investor to gain some control over the firm.
-It includes finance such as pension funds, hedge funds and stock
market money flows.
35
What are the policies that might be used to correct a balance of payments deficit or surplus?
- Fiscal policy
- Monetary policy
- Supply-side policies
36
How might fiscal policies be used to correct a balance of payments deficit?
- If there is a deficit on the current account, income tax could be increased.
-This will reduce the amount of disposable income consumers have, which will reduce the quantity of imports.
-EVAL: However, it might also impact domestic growth, since consumers will also spend less on domestic goods.
- Governments could also reduce their spending.
-This would reduce AD and lead to less imports.
-It forces domestic firms into increasing exports, which helps improve the disequilibrium.
37
How effective are fiscal policies being used to correct a balance of payments deficit or surplus?
| **EVALUATION POINTS**
- Fiscal policy is effective in the short term
- But not so much in the long term.
-As soon as the policy measures end, household are likely to revert their expenditure back on imports.
- If taxes are imposed on trading partners, there is the risk of retaliation, which could reduce demand for exports, too.
- Governments might have imperfect information about the economy, so it could lead to government failure.
- If ‘green taxes’ are implemented, such as carbon taxes, or if there are minimum prices on pollution permits, the competitiveness of domestic firms could be compromised.
-This could reduce exports from domestic firms.
38
Monetary policy:
What is meant by expenditure-reducing policies?
* policies designed to control demand and limit spending on imports
39
Monetary policy-What is the aim of expenditure reducing policies?
- to reduce demand in the economy, so spending on imports fall.
40
Monetary Policy:
What is meant by expenditure-switching policies?
- policies designed to change the relative prices of exports and imports - this causes changes in spending away from imports and towards domestic/export production
41
Monetary policy-What is the aim of expenditure switching policies?
- to switch consumer spending towards domestic goods, and away from imports.
42
How might the monetary policy be used to correct a balance of payments deficit or surplus?
- If there is a current account deficit, the bank might lower interest rates to cause depreciation in the currency.
-this causes exports to become cheaper, and imports to become more expensive
-but it could be inflationary for the domestic economy.
- Moreover, hot money might flow out of the country, since investors are not
receiving a high return on their investment.
- High interest rates could be expenditure-reducing, since the demand for imports falls and inflation might fall.
- Changing the exchange rate could be a government expenditure-switching policy.
43
How effective is the monetary policy being used to correct a balance of payments deficit or surplus?
| **EVALUATION POINTS**
- it is hard to control the supply of money in reality.
- there is a significant time lag with changing the interest rate and seeing an effect.
44
How might supply-side policies be used to correct a balance of payments deficit or surplus?
- Supply-side policies could help increase productivity with increased spending on education and training, -could result in the country becoming more internationally competitive.
-this could lead to a rise in exports.
-(can be an effective policy in the long term)
- Supply-side policies could also help make the domestic economy attractive to investors.
- The domestic economy could be made more competitive through deregulation and privatisation, which will force firms to lower their average costs.
45
How effective are supply-side policies being used to correct a balance of payments deficit or surplus?
| **EVALUATION POINTS**
- Increased spending on education and training incurs significant time lag, so it is not effective as an immediate measure.
- Privatisation could result in monopolies being formed, which will not increase efficiency.
- If governments provide subsidies to some industries to encourage production, there could be retaliation from foreign countries that see this as an unfair protectionist policy.
46
What is the significance of deficits and surpluses for an individual economy?
| **EVAL/ANALYSIS**
- If imported raw materials are expensive, there could be cost-push inflation in the domestic economy, since firms face higher production costs.
- International trade has meant countries have become interdependent.
-Therefore, the economic conditions in one country affect another country, since the quantity they export or import will change.
- A surplus or deficit on the current account could indicate an unbalanced economy, and it could mean the country is too reliant on other economies for their own growth.
- It could be difficult to attract sufficient financial flows in order to finance a current account deficit.
-This could make it unsustainable in the long run.
47
What are the implications for the global economy of a major economy/economies with imbalances deciding to take corrective action?
| **APPLICATION**
- An imbalance suggests that the UK is reliant on the performance of other countries.
-If export markets, such as the EU, become weak, UK economic performance will be affected.
-This was seen during the 2008 financial crisis.
- It could become difficult to finance the deficit in the long run.
- In the Eurozone, current account deficits are of greater concern because the countries have a fixed exchange rate.
-This means they cannot devalue the currency to restore their level of international competitiveness.
- Since 2006, the US deficit with China narrowed and China’s surplus also fell.
-A surplus indicates low consumer spending and a low savings ratio, which puts China at the risk of having unsustainable economic growth.
-(However, the government now aims to grow the economy using domestic spending, rather than exports)
- China made their exports more competitive by undervaluing their currency.
-This makes their imports more expensive
-(however, so it could be inflationary and cause a boom or bust)
- A stronger Yuan causes lower growth, lower inflation and reduces the current account surplus.
-The US would prefer a stronger Yuan since it makes their domestic industries more competitive.
