Week 12 Flashcards
(22 cards)
What is the Balance of Payments (BOP)?
The BOP is a record of all economic transactions between residents of a country and the rest of the world, comprising the current account and capital/financial account.
How does the BOP equation balance?
The BOP is balanced with: BOP = Current Account + Capital Account = 0. This identity implies that any current account surplus or deficit is offset by a corresponding capital account deficit or surplus.
What are the main components of the current account?
Goods: Exports and imports, including trade balance. Services: International spending on services like insurance and freight. Income: Earnings on investments and labor income. Transfers: One-time, non-reciprocal transactions like foreign aid.
How is the balance of merchandise trade calculated?
The trade balance is exports minus imports. A surplus implies exports exceed imports, while a deficit implies imports exceed exports.
What is included in the capital and financial account?
The capital and financial account records flows associated with financial and non-financial assets, as well as changes in official foreign exchange reserves.
How are credits and debits recorded in the capital account?
Credits: Acquisition of liabilities (e.g., foreign loans to residents). Debits: Acquisition of assets (e.g., domestic residents buying foreign assets).
Define capital inflows and capital outflows.
Capital inflows occur when foreign capital enters a country, often through foreign investments or loans. Capital outflows happen when domestic capital is used to purchase foreign assets, leading to an outward flow of funds.
What is net capital inflow?
Net capital inflow is the difference between capital inflows and outflows. Positive inflows can help finance domestic investment beyond national savings.
Why must the current account balance and capital account balance sum to zero?
In a floating exchange rate system, current account deficits must be financed by capital inflows, while surpluses imply capital outflows.
What changes occur under a fixed exchange rate system?
In a fixed system, changes in foreign exchange reserves are used to maintain the pegged rate, leading to adjustments in capital flows and reserve levels.
What is the relationship between saving, investment, and net exports?
National savings (NS) minus investment (I) equals net exports (NX). High savings relative to investment implies a trade surplus, while low savings leads to a trade deficit.
How does low national saving affect the trade balance?
Low national savings, relative to investment needs, typically results in a trade deficit, as foreign savings are needed to finance domestic investment.
What determines whether a country has net capital inflows or outflows?
Net capital flows depend on relative returns and risk levels. Higher domestic returns attract inflows, while higher risk in a country can discourage inflows.
What happens if the domestic interest rate is above the foreign rate?
Higher domestic interest rates attract capital inflows, increasing demand for domestic assets, which can lead to an appreciation in the currency.
What are the benefits of capital inflows?
Capital inflows provide additional resources for investment, supporting economic growth and potentially raising productivity.
What risks are associated with capital inflows?
Heavy reliance on foreign capital can lead to debt accumulation, currency crises, and pressure to make interest or dividend payments to foreign investors.
What is a capital account surplus?
A capital account surplus occurs when foreign investments in domestic assets exceed domestic investments in foreign assets, reflecting net capital inflows.
How does a current account deficit relate to a capital account surplus?
A current account deficit is financed by a capital account surplus, meaning the country is borrowing or attracting investments from abroad.
What is the Twin Deficits Hypothesis?
The Twin Deficits Hypothesis suggests a link between budget deficits and current account deficits. A decline in national savings, often from a budget deficit, may increase the current account deficit.
How do twin deficits affect interest rates?
Twin deficits can drive up interest rates by increasing demand for funds, potentially attracting foreign capital inflows and affecting the exchange rate.
How did Greece’s balance of payments contribute to its debt crisis?
Greece’s high fiscal deficits and reliance on foreign capital led to large current account deficits. When capital inflows stopped, the country faced a debt crisis due to insufficient domestic savings and high external liabilities.
What were the consequences of Greece’s debt crisis?
The crisis led to economic contraction, austerity measures, and long-term fiscal adjustments to stabilize the balance of payments and reduce external debt.
