Macro 4: Balance of Payments and Trade

Question 1

What are the three accounts on the BoP?

Answer 1

The current account, capital account and financial account.

Question 2

What does the BoP record?

Answer 2

All flows of money into and out of a country.

Question 3

What are the 4 sections in the current account?

Answer 3

1) Trade in goods- (visible trade) this measures the imports and exports of visible goods eg. TVs, books
2) Trade in services- (invisible trade) this measures the imports and exports of invisible services like insurance or tourism
3) Primary income- this covers the flow of money in and out of a country resulting from employment or earlier investment, eg. deposits in foreign banks receive interest payments, businesses set up overseas by a UK company will earn profits for the UK parent company, shares bought in foreign firms will bring dividend payments to the UK shareholder, salaries paid to UK residents working abroad
4) Secondary income- Transfers are the movements of money between countries which aren’t paying for goods or services and aren’t the result of investment, eg. payments made to family members abroad and aid paid to or received from foreign countries

Question 4

What is the capital account?

Answer 4

The transfers of non-monetary and fixed assets.

Question 5

What is the financial account?

Answer 5

The movement of financial assets.

Question 6

What does the capital account measure?

Answer 6

Debt forgiveness, inheritance taxes, death duties, sales of tangible/intangible assets, transfers of financial assets by migrants.

Question 7

What does the financial account involve?

Answer 7

1) Portfolio investment- buying and selling of financial assets, eg. bonds, shares
2) Foreign direct investment- a firm based in one country making investment in another country
3) Reserve assets- financial assets held by the Bank of England to be used as and when they’re needed
4) Financial derivatives- contracts whose value is based on the value of an asset, eg. foreign currency

Question 8

What 3 things cause a current account deficit?

Answer 8

1) High levels of consumer spending (low savings rate)- when there’s economic growth, consumers and firms buy more imports, if the income elasticity of demand for imports is high there’ll be a greater increase in imports
2) It’s struggling to compete internationally- reduction in exports, rise in value of currency means goods more expensive to foreign buyers, so exports fall and imports rise (foreign goods cheaper)
3) It has to deal with external shocks

Question 9

What 3 things cause a current account surplus?

Answer 9

1) Recession- producers struggle to sell domestic goods domestically so compete in international markets instead, so fall in imports
2) Domestic currency has low value- exports cheaper imports expensive
3) High interest rates- more saving less spending

Question 10

What happens if inflation rises?

Answer 10

Exports fall as more expensive and less competitive in foreign countries, imports rise.

Question 11

What is the UK’s BoP?

Answer 11

-Large deficit on balance of visible trade- imports more than exports
-Small surplus on balance of invisible trade- exports slightly more services than imports
-Surplus on flows of investment income- receives more payments from investment than it pays out
-Deficit on transfers- eg. foreign aid payments

Question 12

What does the UK have on its current account?

Answer 12

Large deficit

Question 13

Why is a BoP deficit not always a bad thing?

Answer 13

It could mean people are wealthy enough to afford lots of imports and higher living standard as they can import what they want and need.

Question 14

What are the consequences of a BoP deficit?

Answer 14

Fall in value of currency so higher import prices so rise in inflation.
Job losses domestically because more imports means fewer goods need to be produced domestically, so rise in unemployment.

Question 15

What happens if there’s a surplus for a prolonged period of time?

Answer 15

Stagnation- due to low domestic demand they experience low, or negative economic growth which can also lead to high unemployment.

Question 16

Why might a large surplus occur?

Answer 16

-An economy’s overreliance on exports.
-Undervalued currency which creates inflationary pressures- price of imported components for use in production will rise, so rise in costs of production and rise in price level.

Question 17

What should the BoP be?

Answer 17

Balanced at 0.
Current account should balance capital and financial combined.

Question 18

How might a government try to correct a BoP deficit?

Answer 18

-Policies to reduce prices of domestic goods to increase exports and reduce imports
-Restrictions on imports like tariffs so they’re more expensive for domestic consumers
-Devalue/depreciate currency so exports cheaper and imports more expensive
-Fiscal/monetary policy to reduce spending

Question 19

How might a government try to correct a BoP surplus?

Answer 19

-Raise value of currency so reduced demand for exports and increased demand for imports