Balance of payments

Question 1

What is the balance of payments?

Answer 1

The balance of payments records a country’s trade in goods, services and financial assets with the rest of the world.

Question 2

What type of bookkeeping does the BOP use?

Answer 2

The balance of payments uses double-entry bookkeeping, where every transaction is entered as both a credit and debit value

Question 3

What are BOP credits?

Answer 3

Balance of payments credits are entries that bring foreign exchange into the country.

Question 4

What are BOP debits?

Answer 4

Balance of payments debits are entries that result in foreign exchange leaving the country.

Question 5

Describe a BOP deficit

Answer 5

A balance of payments deficit is when more foreign exchange leaves the country than enters (Debits>Credits)

Question 6

Describe a BOP surplus

Answer 6

A balance of payments surplus is when more foreign exchange enters the country than leaves (Credits>Debits)

Question 7

What areas can have a BOP deficit/surplus?

Answer 7

There can be surpluses in deficits in: Merchandise (Goods), services, investments, unilateral monetary transfers etc, the flow of gold and money, foreign investment

Question 8

What must a deficit or surplus refer to?

Answer 8

A deficit or surplus must refer to a certain class of transactions on the balance of payments balance sheet, such as unilateral transfers. Due to the double-entry bookkeeping method used in the balance of payments, there is never an overall surplus or deficit, as both debit and credit sides remain equal.

Question 9

What is the current account?

Answer 9

The current account is the balance of trade in goods, services, investment income and unilateral transfers between 2 countries.

Question 10

What are examples of investment income?

Answer 10

Investment income in this example includes foreign payments to capital/labour/land owned by domestic firms, and domestic payments to capital/land/labour owned by foreign firms.

Question 11

What are examples of Unilateral transfers?

Answer 11

Unilateral transfers include gifts, pensions and foreign aid.

Question 12

What is the capital account with examples?

Answer 12

The capital account details the balance of investments between two countries, including the value of investments in stocks, bonds, and direct asset purchases

Question 13

What is a capital account surplus and deficit?

Answer 13

The capital account surplus is when the value of foreign investments made in domestic assets exceeds the value of domestic investments in foreign assets. A deficit is when the value of domestic investment in foreign assets is larger than the total foreign investments in domestic assets. We say there are ‘more capital flows into/out of’ a country.

Question 14

What are the two types of transactions that the capital account includes?

Answer 14

The capital account includes public/official transactions, which are investments made by government entities, and private transactions, which are investments made by private business, households and consumers.

Question 15

What are examples of private transactions?

Answer 15

• Direct investment: Private sector investments in foreign firms
• Security purchases: Purchasing and selling stocks and bonds
• Banks claims and liabilities: Bank loans and deposits abroad

Question 16

What is the official settlement balance?

Answer 16

The official settlements balance is the change in domestic official reserve assets plus the change in foreign official assets in the domestic country.

Question 17

What is statistical discrepancy and what is its effect?

Answer 17

Statistical discrepancy is when countries fail to report certain payments regarding the BOP or other balances, and it has the effect of making a certain country’s financial situation seem disingenuously better or worse than it actually is.

Question 18

What are 3 reasons for the large US trade deficit?

Answer 18

• Unfair trade: The US is more open to trade than other closed countries
• Twin deficit: The US government runs a budget deficit, so they would therefore have a trade deficit
• Investment demand shift: US assets and companies are popular investments, attracting large capital inflows

Question 19

What is private saving and the formula?

Answer 19

Private saving is the income after tax, minus consumption spending. The formula for which is Y-T-C

Question 20

What is public sector saving and the formula?

Answer 20

Public sector saving is the difference between government income and expenditure, given by the formula T-G.

Question 21

What are the two main ways a trade deficit occurs?

Answer 21

The two main ways a trade deficit occurs are through the twin deficits hypothesis, and the investment demand shift.

Question 22

If there is a trade deficit. then how can the government plug the gap?

Answer 22

If there is a trade deficit, and the twin deficits hypothesis holds, then the government can relieve the gap by reducing the fiscal deficit. If the investment demand hypothesis holds, then the government can reduce foreign investment through legislature.

Question 23

Explain the process of a budget deficit leading to a trade deficit

Answer 23

Fiscal deficit – government sells bonds – higher demand for currency – currency appreciates – exports become more expensive – lower demand for exports – trade deficit

Question 24

Trade deficit is a symptom of foreigner’s belief in…

Answer 24

Trade deficit is not always a bad sign, as it is a symptom of foreigner’s belief in the strength of the domestic country’s economy.

Question 25

Countries can have a negative/positive equilibrium balance on the current account depending on …

Answer 25

Countries can have a negative or positive equilibrium balance on the current account depending on the sustainability of the situation. For example, the US can finance a trade deficit by selling bonds, as the demand for US government debt is always high.

Question 26

Under a floating exchange rate, how is BOP eqm restored?

Answer 26

Under a floating exchange rate, the balance of payments equilibrium is restored by the natural adjustment of the exchange rate.

Question 27

Under a fixed exchange rate, how is BOP eqm restored?

Answer 27

Under a fixed exchange rate, however, the balance of payments equilibrium must be restored “manually”, by governments using foreign reserves to adjust the exchange rate, or imposing trade restrictions such as tariffs in order to stem the flow of trade.

Question 28

What is the main problem with enforcing tariffs etc?

Answer 28

The main problem with enforcing tariffs, however, is the threat of retaliation. This is arguably dependent, though, on the relative size of the trade between the two countries relevant to their respective sizes.

Question 29

What is the definition of elasticity of demand?

Answer 29

The elasticity of demand is the responsiveness of quantity demanded to a change in price. The higher the elasticity, the higher the responsiveness.

Question 30

What is the definition of elasticity of supply?

Answer 30

The elasticity of supply is the responsiveness of quantity supplied to a change in price. The higher the elasticity, the higher the responsiveness.

Question 31

In traditional exch. rate theory, the supply of FOREX to a nation results from:

Answer 31

In traditional exchange rate theory, the supply of FOREX to a nation results from the goods and services exports and imports of the country.

Question 32

How are the elasticity of import demand and a certain currency demand linked?

Answer 32

We would expect that the elasticity of demand for exports and the elasticity of demand for the export currency to be linked.

Question 33

How are the elasticity of export supply and a certain currency supply linked?

Answer 33

We would expect the elasticity of supply for exports and the elasticity of supply for the relevant foreign exchange to be linked.

Question 34

What did the elasticities approach center/focus on?

Answer 34

The elasticities approach centers on the changes in the prices of goods and services as the main determinant of a nation’s balance of payments and exchange value for it’s currency.

Question 35

What is exchange rate instability?

Answer 35

Exchange rate instability is the situation in which a currency depreciation increases the difference between the quantity of foreign exchange supplied and the quantity of foreign exchange demanded, instead of increasing the difference.

Question 36

What is the Marshall-Lerner condition?

Answer 36

The Marshall-Lerner is a necessary condition for exchange-rate stability, in which the sum of the elasticity of import demand and the elasticity of export supply must exceed unity (1).

Question 37

What is the relationship between time and elasticity?

Answer 37

As time increases, we would expect demand and supply to be more elastic as they are able to adjust to new prices or seek out alternatives. In the short term agents are less able to make this adjustment, so demand and supply will be less elastic.

Question 38

What is the J curve effect?

Answer 38

The J curve effect states that a depreciation of the domestic currency causes a nation’s balance of payments situation to worsen before it improves/gets better.

Question 39

What is absorption?

Answer 39

Absorption is the theory that emphasises the role of a nation’s expenditures (absorption/income). The theory states that if a nation’s real income exceeds its absorption, then the country will run a current account surplus.

Question 40

What is a nation’s real income?

Answer 40

A nation’s real income is represented by the formula C+I+G+X. It is the nation’s real expenditures on it’s output of final goods and services.