lesson 5: the balance of payments

Question 1

what are the three accounts that makes up the balance of payments?

Answer 1

the financial account
the current account
the capital account

Question 2

why is the financial account significant?

Answer 2

flow of investment into and out of the UK including FDI

Question 3

why is the current account significant?

Answer 3

inflow and outflow of trade of goods and services, income including from FDI and transfers between the UK and other countries

Question 4

why is the capital account significant?

Answer 4

small section that covers debt forgiveness and buying/selling non physical assets like copyrights

Question 5

What is the balance of payments?

Answer 5

The record of all financial and transactions between one country and the rest of the globe

Question 6

what does FDI increase?

Answer 6

jobs
skill level
aggregate demand
LRAS

Question 7

what are the four parts of the current account?

Answer 7

trade in goods
trade in services
investment incomes
current transfers

Question 8

what will happen to the current account if we increase our imports?

Answer 8

decrease due to the leakages in the circular flow of incomes leaving

Question 9

what are the reasons why the UK has a deficit on the current account of the BOP?

Answer 9

1) strong currency —> decrease in price of imports + increase price of exports —> imported inflation

2) lack of demand abroad —> global slow down

3) low productivity —> supply side policies

Question 10

what are the reasons why FDI is a good thing for an economy?

Answer 10

1) increased economic growth —> jobs

2) increased access to global markets

3) infrastructure development

Question 11

what are the ways the UK might reduce the deficit on the current account?

Answer 11

1) invest in education

2) weaken the currency —> decrease interest rates + sell the currency

Question 12

what is the battle of the uglies?

Answer 12

everyone trying to weaken their currencies to make their exports cheaper but lowering interest rates and selling the currency

but everyone weakening their currency will lead to imported inflation

Question 13

what will investment income received by the UK companies by foreign investors appear as on the UK current account?

Answer 13

When investment income is received by UK companies by foreign investors, it will appear as a positive number on the UK Current Account, which will increase

Question 14

what will investment income paid by the UK companies to foreign investors appear as on the UK current account?

Answer 14

When investment income is paid by UK companies to foreign investors, it will appear as a negative number on the UK Current Account, which will decrease

Question 15

what is a portfolio investment?

Answer 15

purchase of financial assets like bonds or shares rather than productive assets like factories

Question 16

formula for trade balance

Answer 16

(value of exported goods + services) - (value of imported goods + services)

Question 17

what is the issue with hot money

Answer 17

hot money can be destabilising since money may be pulled out quickly if interest rates drop or expectations change

Question 18

what is the balance of trade? what is important to remember about it?

Answer 18

the difference between the total value of exports and imports

important: THIS IS VISIBLE TRADE

Question 19

what else is the balance of trade in goods referred to as?

Answer 19

visible trade

Question 20

what else is the balance of trade in services referred to as?

Answer 20

invisible trade

Question 21

what are transfers?

Answer 21

payments flowing between countries in forms such as foreign aid, grants and payments to the EU

Question 22

what is net income flows?

Answer 22

shows income earned by uk firms minus income earned in the uk by overseas firms

Question 23

reasons why the UKs current account may be in a deficit?

Answer 23

strong currency
inflation
productivity
quality
falling incomes abroad
rising incomes at home

Question 24

what are policies used to cure a current account deficit? the three Ds

Answer 24

the three Ds

deflation
direct controls
devaluation

Question 25

how can deflation be used to cure a current account deficit?

Answer 25

contractionary policy to reduce AD reduces demand for import but carries the risk of unemployment and likely to have a small impact

Question 26

how can direct controls be used to cure a current account deficit?

Answer 26

import controls like tariffs and quotas tends to provokes retaliation doesn't cure the underlying problem of lack of competitiveness

Question 27

how can devaluation be used to cure a current account deficit?

Answer 27

weaken the exchange rates change the relative price of domestic and foreign goods effectiveness depends on elasticities

Question 28

does weakening the currency work?

Answer 28

short run the BOP may deteriorate long run the BOP may improve ---> depends on elasticities however this may not last as any price competitiveness produced by the devaluation in likely to be eroded by increased import prices driving up inflation shown by the J curve

Question 29

when do we have a current account surplus?

Answer 29

when money is coming into the economy

Question 30

what are two negatives of a current account surplus?

Answer 30

may upset your trading partners one countries surplus is the cause of another's deficit

Question 31

what are the three policies to fix a current account surplus?

Answer 31

reflation - expansionary policies as governments cut taxes so theres greater disposable incomes---> increase AD ---> demand for imports removing import controls like liberalise trade + remove barriers to encourage more imports ---> this reuces the surplus but also increases living standards as we have more options revaluating - strengthen the exchange rate ---> makes exports more expensuve ---> reducing demand ---> reducing the surplus

Question 32

what are gilts?

Answer 32

british government bonds

Question 33

what is a run on the pound?

Answer 33

when investors lose confidence in the british currency leading to a decline in its value

Question 34

define a current account deficit

Answer 34

When total outflows from the current account are greater than total inflows. pay more than we recieve reverse outflows for inflows for surplus