Macro 20 - imbalances in the balance of payments.

Question 1

what is the affect of a current account deficit to the UK?

Answer 1

• More leakages, so less AD.
• More unemployment- derive demand.
• growth will fall.
• inflation falls.
• Budget deficit increases- less tax and more benefits.

Question 2

define the current account?

Answer 2

The balance of trade of goods and services + net income.

Question 3

define current account surplus?

Answer 3

The value of exports is greater than the value of imports.

Question 4

define current account deficit?

Answer 4

The value of imports is greater than the value of exports.

Question 5

In which direction does the money flow during a CA deficit and CA surplus?

Answer 5

Deficit - money flows out of the economy.
Surplus - money flows into the economy.

Question 6

5 reasons why the UK runs a current account deficit?

Answer 6

1. Deindustrialisation.
2. Rising incomes.
3. Low productivity.
4. Strength of the pound.
5. Island nation.

Question 7

Explain and evaluate “deindustrialisation” as a reason of why the UK runs a CA deficit?

Answer 7

The UK economy has transitioned from the secondary sector to tertiary sector. Comparative advantage in financial sector and lost advantage in manufactured goods. This means companies have outsourced and moved operations to countries like china.

Eval:
- UK still has a manufacturing industry (10%), so its still important for the economy. Also has a sizable number of employment in textiles.
- Could be other reasons such as countries like china and germany producing better quality goods.

Question 8

Explain and evaluate “Rising incomes” as a reason of why the UK runs a CA deficit?

Answer 8

The UK saw a rise in incomes and strong economic growth. As incomes increase, imports increased. MPM of the UK is high.

Eval:
More than a decade ago, real income is now fallen due to inflation.

Question 9

Explain and evaluate “Low productivity” as a reason of why the UK runs a CA deficit?

Answer 9

Higher cost per unit which is passed on, increasing PL. Less internationally competitive. Deficit widens.

Eval:
- costs may not be passed on.
- Depends on the price of imports in relation. If import prices are also rising, change in exports will be low.

Question 10

Explain and evaluate “strength of the pound” as a reason of why the UK runs a CA deficit?

Answer 10

Strong pound makes exports less competitive and so demand for exports fall. Widens CA deficit as imports also become cheaper and so demand for imports increases.

Eval:
- depends on the extent of the appreciation of the pound. The pound isn’t as strong as it used to be and is even weaker since Lizz truss crashed the economy.

Question 11

Explain and evaluate “island nation” as a reason of why the UK runs a CA deficit?

Answer 11

UK runs a structural CA deficit as its an island nation. It has to import raw material, capital goods, food and others. It’s always going to be reliant on imports.

Question 12

What is the impact of a rising CA deficit on the economy on a diagram?

Answer 12

SHIFT AD TO THE LEFT.
Net exports is a component of AD.

Question 13

what does it depend on if the UK economy is actually suffering form a CA deficit?

Answer 13

• Depends on the length of the deficit.
• Depends on if the deficit is funded through the loss of competitiveness.
• Depends on if the deficit is going to lead to more borrowing.

Question 14

Explain “Depends on the length of the deficit.”

Answer 14

Theoretically, a recession should cause the CA deficit to narrow as price of exports decrease and demand for imports decrease. These are called cyclical CA deficits.
However, UK runs a structural CA deficit all the time, regardless of the economic situation

Question 15

Explain “Depends on if the deficit is funded through the loss of competitiveness”

Answer 15

UK’s loss of competitiveness could be caused by low productivity, as that is a structural problem.

Question 16

Explain “Depends on if the deficit is going to lead to borrowing”

Answer 16

CA deficit is a concern when it has to be financed through borrowing. When you have no money to finance, it’s called a CA crisis.

Question 17

what are private debts?

Answer 17

Any debts that households borrow.
Eg: Credit card debts, mortgages, student loan.

Question 18

6 reasons why it is a problem for UK growth to be consumption led?

Answer 18

1. Demand pull inflation.
2. Short run only.
3. Risky as in recession, consumption is low and can decline growth - too reliant on AD.
4. Consumption led by borrowing is a problem.
5. Consumption can also be importing.
6. Not enough saving.

Question 19

define expenditure SWITCHING policies?

Answer 19

Policies implemented to increase price of imports to reduce the demand for them or decrease price of exports to increase demand for them.

Question 20

define expenditure REDUCING policies?

Answer 20

Policies to reduce the GDP to reduce the amount of imports.

Question 21

Explain and evaluate “demand side policy” as an expenditure REDUCING policy

Answer 21

• Govt can increase taxes or interest rates.
• Less RDI. COnsumption falls. Less demand for imports and so imports fall.

Eval:
- Unlikely to use this policy as it sacrifices a big macro objective of growth. especially harmful as growth has been stagnant in the UK.
- Island nation. Demand for imports is inelastic. Raw materials are also bought on long term contracts.
- Depends on the extent of the tax increase.

Question 22

Explain and evaluate “supply side policies” as an expenditure SWITCHING policy

Answer 22

Investment in capital goods or subsidies. COP falls, passed onto consumers. SRAS shifts to the right. Demand for exports increase.

Eval:
- Can be expensive and may require tax breaks.
- Uncertainty may put off investors.
- Other factors such as rising incomes may determine CA deficit.
- Quality is a significant factor, for example german cars.

Question 23

Explain and evaluate “lower exchange rates” as an expenditure SWITCHING policy

Answer 23

Reduce value of pound by lowering interest rates. Hot money flows out and demand for pound decreases, leading to a depreciation. Price of exports fall and therefore demand for them increases.

Eval:
-Time lag.
- Unlikely to be used as UK is facing inflationary pressure.
- Increases price of imports which have an inelastic demand, leading to lower living standards or cost push inflation.

Question 24

Explain and evaluate “protectionism” as a expenditure SWITCHING policy

Answer 24

Impose tariffs. Raises costs, which are passed on. Price of imports increases and so demand decreases.

Eval:
- Goes against the principle of free trade, where demand and supply allocates price levels.
- Retaliation , can start a trade war and so prices of goods in other countries increases.

Question 25

why might a sustained and large current account surplus be a problem?

Answer 25

• Demand pull inflation, depending on where the economy lies.
• Countries like the UK can’t reduce deficit if countries like germany have a surplus. Because UK will continue to buy better quality goods from germany.
• countries like germany and japan have high savings ratio, and so are less likely to buy UK imports.

Question 26

What are the causes of a current account surplus?

Answer 26

• Weak Pound value.
• Recession.
• Low consumer spending.
• Deflation.
• Boom in other countries.
• High interest rates.
• High productivity.
• Trade blocs.

Question 27

How can a current account surplus be corrected?

Answer 27

• Lower tariffs.
• Decrease income tax.
• Lower interest rates - hot money flow.
• Currency appreciation.