Balance Of Payments (Current Account)

Question 1

What is the Balance of Payments?

Answer 1

A record of all the financial transactions made between consumers, firms and the government from one country to another

Question 2

What is the current Account?

Answer 2

These measure the flows (the amount of money leaving and entering the country) - measuring value not volume
Definition - all economic transactions between countries

Question 3

What does the Current Account measure?

Answer 3

1) Measures Trades in Goods - exports and imports of goods, how much money spent on imports and revenue made from exports.
2) Measures Trade in Services - exports and imports of services
These both make the balance of trade, when discussing trade performance it is a focus on these aspects
3) Measures investment Income - measures flows of income, income entering the country or leaving. E.g. remittances, when a uk worker goes abroad and works abroad and earns income, if this income is broad back to the UK it will be a positive on the current account. How much money is leaving and entering the country in terms of income
4) Measures Transfers - can be Gov transfers, payment of EU fees, contribution of AID to India for example or other developing countries
These both make total income balance

Question 4

What is a current account deficit caused by? Demand side

Answer 4

1)Strong domestic growth - incomes are high, living standards are high, people are more willing to buy our imports because incomes are greater and so have a larger incentive to consume
2)Recession overseas - incomes abroad are falling, demand for our exports is reduced, money generated from exports decreases
3) Strong exchange rate - imports cheaper, exports expensive

Question 5

What is a current account deficit caused by? Supply-side reasons

Answer 5

1) Low investment
2) Low productivity
3) High relative inflation
4) High unit labour costs
These four main points make our exports less competitive to other countries
5) Poor quality/ reliability -
6)Depletion of resources - UK was big exporter of North Sea oil, when the oil reserve depleted, our exports fell

Question 6

Consequences of current account deficit? (Effect on AD)

Answer 6

1) Lowers AD (X-M) downwards (Shift on a Keynesian LRAS curve the AD left)

Question 7

Consequence of a current account deficit? (Burdens)

Answer 7

Debt burdens - eventually investors may lose confidence in a countries ability to pay the debt back, loss of investors causes consumer loss in confidence due to lack of income stream. More people move their money away from the country which could include selling the pound if it’s the UK, this reduces value of pound and leads to a currency crisis. People that have debt, savings or money held in the UK will see it lose value and will move their money from the UK even more causing a possible economic crisis by being unable to finance deficit

Question 8

Consequence of a Current account deficit? (Exchange rate)

Answer 8

Decrease Exchange rate - Importing more than exporting, supply of currency increases shifting S rightwards
In theory WPIDEC would help increase the level of demand for exports, correcting CA deficit which is potentially true BUT if there is a deficit prior to this, could be a sign of a lack of competitiveness so by making exports cheaper there is no guarantee of increase in export demand - more likely for UK to suffer from higher import prices which could lead to stagflation (increase in costs of production for firms)
Issue only when current account is large percentage of GDP
Year one: Appreciation of the currency - imports cheaper, exports dearer, deficit worsens