Balance Of Payments

Question 1

What is the balance of payments (BOP)

Answer 1

Records of all economic transactions between residents of an economy and the rest of the world

Question 2

Components of BOP

Answer 2

Current account
Financial account
Capital account
Net errors of emissions

Question 3

What is current account

Answer 3

Covers all transactions related to international trade in good and services - as well as primary and secondary flows from abroad

Question 4

What is financial account

Answer 4

Covers transactions that result in a change of ownership of financial assets and liabilities between UK residents and foreign residents

Question 5

What is a capital account

Answer 5

Covers sale/purchase of non produced and non financial assets such as patent, copyrights, leases and franchises.

Question 6

Components of current account (1)

Answer 6

Trade balance: a measure of the net international trade in goods and services. The trade balance records the total value of exports minus the total value of imports
Exports: (+) credit item on the current account (money flowing in)
Import: (-) debit item on the current account (money flowing out)
If value of imports is greater than value of imports there is a trade deficit
If value of exports is greater than value of imports there is a trade surplus
2. Primary income balance
3. Secondary income balance

Question 7

Component of current account (2)

Answer 7

Primary income (investment income) balance: the is the value of total earnings received by domestic residents from assets located outside the domestic economy and the total income paid out to foreign owners of assets located in the domestic economy

Secondary income (transfers) balance: net balance on one-way transfers into and out of the domestic economy

Question 8

What is a credit item

Answer 8

Money earned by domestic residents and flowing into the country

Question 9

What is a debit item

Answer 9

Money flowing out to foreigners count as a debit item

Question 10

Current account surplus

Answer 10

Trade balance + net primary and secondary income balance > 0
More money is flowing into the country than is flowing out

Question 11

Current account deficit

Answer 11

Trade balance + net primary and secondary income balance < 0
More money is flowing out of the country than is flowing in

Question 12

Factors influencing current account balance

Answer 12

1. Economic activity in domestic economy
2. Economic activities in other countries
3. Inflation rate in the domestic economy
4. Productivity growth in the domestic economy
5. The exchange rate

Question 13

Possible consequences of CA deficit part 1

Answer 13

1. Downward pressure on the exchange rate
   2.Reduced foreign exchange reserves
2. Increased foreign ownership of domestic assets
3. Loss of domestic sovereignty

Question 14

Possible consequence of CA deficit part 2

Answer 14

1. Possible increase in foreign debt
2. Possible increase in domestic borrowing cost
3. Possible lack of funds to support domestic demand management
4. Negative impact on international credit ratings

Question 15

Economic activity in the domestic economy

Answer 15

Increasing economic activity in the domestic economy is likely to increase the demand for imports, reducing net exports. This is because higher incomes for firms households and government is likely to increase aggregate demand some of which will be satisfied through the purchase of imports.

Question 16

Economic activity in other countries

Answer 16

Increase economic activity in other countries is likely to increase the demand for exports, increasing net exports. This is because a higher income for foreign households, firms and government ius like to increase external demand, increasing the total value of exports

Question 17

Inflation rate in the domestic economy

Answer 17

-a low rate of inflation is likely to increase the relative price competitiveness of domestically produced goods and services
- if price of domestically produces goods rises slower than the price of good and services produced in a foreign economy there should be an increase in the demand for exports and a decrease in the demand for imports

Question 18

Productivity growth in the domestic economy

Answer 18

• higher productivity growth in domestic economy is likely to increase the relative price competitiveness of domestically produced goods over time
• as average costs of domestic production fall relative to foreign production domestic good should become more price competitive
• increase in demand for exports and a fall in demand for imports
• therefore, rising productivity growth in the domestic economy should lead to a fall in the CA deficit

Question 19

The exchange rate

Answer 19

The exchange rate is the price of one currency inn terms of another currency
A fall in the exchange rate is likely to increase the relative price competitiveness of domestically produced goods for foreign buyers as less foreign currency is required to buy goods priced in the domestic currency
This should lead to an increased in demand for exports and fall in demand for imports (as price of imports rise for domestic buyers)
-> decrease in CA deficit

Question 20

Evaluation for a current account deficit or surplus)

Answer 20

1. The seize of the current account deficit or surplus
2. The duration
3. Cause of the CA (deficit or surplus)

Question 21

Can the economy afford a CA deficit ?

Answer 21

If country continues to attract portfolio and direct investment from abroad, it will be able to finance its CA deficit and afford imports. This is more likely in an economy which is growing

If a country has a large existing stock of domestic resident owned assets. It is able to finance its current account deficit for longer