1.2.3 Balance of Payments

Question 1

What is the balance of payments?

Answer 1

• All financial transactions in a country with other nations
• Inflows/Outflows recorded

3 main accounts:

• Capital account
• Current account
• Financial account

Question 2

What is the current account?

Answer 2

-Measures flows of income, money and credit in and out of the economy, consisting of 3 main sources:

Trade: balance of trade in goods/services.
Goods are tangible/visible e.g. manufacturing, materials, capital
services are intangible/invisible such as banking, tourism, research and transport

Net primary income: flow of profits, interest, investment, dividends and remittances from other countries

Net transfers/secondary income: overseas aid, debt relief, UK payments to EU, remittances, transfers of money to UK by nationals who come to live here.

Question 3

What is the capital and financial account?

Answer 3

-Capital account is inflows of capital e.g. FDI, combined with financial account

Financial count is the in and outflows spent on capital goods e.g. if a firm buys factories abroad or opens shops abroad or buys shares from a foreign firm

Question 4

Why may a deficit matter/not matter?

Answer 4

Matters:

• Loss of ADP, slower growth and SOL
• Loss of jobs and employment
• Currency weakness and higher inflation, short run of vital foreign currency reserves
• May be reflection of a lack of competitiveness/supply side weakness
• Government failed to meet objectives
• Economy shrinks
• Markets volatile so cannot afford later
• Decline in UK manufacturing

Does not matter:

• Attracts enough FDI to finance
• Deficit only really matters if over 5%
• Short run deficit not really issue if from buying capital as will see returns in the future

Question 5

What are the causes of a current account deficit?

Answer 5

• Poor price/non pric ecompetitiveness - relative inflation, low capital investment, weak design, innovation, branding performance and productivity
• Strong exchange rates - SPICED - imports more
• Recession in partner countries - cuts value there
• Volatile global prices - exporters of commodities may be hit by fall in global prices, importing nationals may be hit by oil prices

Domestic economy - domestic producers import more raw materials from abroad. High importing households may import more with better incomes