Balance of Payments

Question 1

define BOP

Answer 1

BOP of a country is a record of economic transactions btwn the residents of a country and the ernst of the world over a period of time (usually a year)

Question 2

what constitutes a current account?

Answer 2

current acc = earning - spending

Question 3

what constitutes the spending?

Answer 3

capital account & change in official reserves ($ kept by govt)
- BOT (X-M)
- net income on capital invested abroad
- net unilateral transfers (foreign aid)
- net investment income earned by citizens
capital account (ST and LT capital flows)
- FDI
- portfolio investment (stocks and bonds)
- others (mvmt of capital from one country to another) (eg: shifting bank deposits)

Question 4

what are the causes of BOP surplus/ deficit?
hint: 4

Answer 4

1. inflation
   
   • inflation → Xrev increases + Mexp increases → BOT deficit
2. economic growth
   
   • higher RNY → increased purchasing power → Mexp increases → BOT deficit (assuming the country experiences more econ growth than major trade partners)
3. exchange rate
   
   • appreciation → Mexp increases + Xrev decreases (assuming PED>1) → BOT deficit
4. interest rates
   
   • ir decreases → decreased cost of borrowing → Mexp increases → BOT deficit

Question 5

define terms of trade (TOT)

Answer 5

TOT is the index of X prices divided by the index of M prices

Question 6

how does TOT work?
*link to X and M, & PED

Answer 6

X prices increase faster than M prices → improvement in TOT
assume PEDx > 1: higher X prices → MTP decrease in Qd of exports → Xrev decreases
assume PEDm > 1: lower M prices → MTP increase in Qd of imports → Mexp increases
→ → worsened BOT under current acc balance

Question 7

what are the factors that affect international competitiveness?
hint: 4 factors

Answer 7

1. edu level of work force
2. productivity
3. inflation rate
4. qlty of institutions

Question 8

what factors change a capital account?
hint: 4 factors

Answer 8

1. interest rates
   
   • affects hot money flow (ST capital flow)
   • ir decreases relative to the world → outflow of hot money (bc returns decrease) → worsening cap & financial acc
2. inflation rate
   
   • high inflation rate → prices of factor inputs increase at a higher rate → COP increases → deters investors → outflow of FDI → worsening cap & financial acc
3. global demand conditions
   
   • deteriorates during recessions → decreases business confidence → decrease inflows of FDI → greater net outflow under LT cap flows → worsened cap & financial acc
4. changes in intl competitiveness
   
   • economy becomes less globally competitive → relatively less attractive to MNCs → deters MNCs from setting up factories there → decreases inflows under LT cap flows → worsened cap & financial acc