2.1.4 4.1.7 Balance of payments

Question 1

Balance of payments

Answer 1

A record of all financial transactions made between consumers, firms and the govt from one country with other countries.
It states how much is spent on imports, and what the value of exports is.

Question 2

Exports and Imports

Answer 2

X: goods and services sold to foreign countries, positive in the
balance of payments as they are an inflow of money
M: goods and services bought from foreign countries, and they are negative on the balance of payments as they are an outflow of money

Question 3

Balance of payments components

Answer 3

(A2C and OFA): the Current account, the Capital account, the official financing account

Question 4

The current account

Answer 4

The current account on the balance of payments is the balance of trade in goods and services

Question 5

Current account deficits and surpluses

Answer 5

A current account surplus means there is a net inflow of money into the circular flow of income.
A current account deficit means a country’s imports exceed the value of exports.

Question 6

UK deficits and surpluses

Answer 6

The UK has a surplus with services, but a deficit with goods.
The UK has a current account deficit, meaning they spend more on imports from foreign countries than they earn from exports to foreign countries.
- If the deficit is large and runs for a long time, there could be financial difficulties with financing the deficit.

Question 7

Relationship between current account imbalances and other macroeconomic objectives

Answer 7

• Exporting more to foreign countries creates a greater inflow of money into the circular flow of income, increasing AD and improving the rate of
  economic growth.
• In the UK during periods of economic decline/recessions, the current account deficit falls as consumer spending falls.
• During periods of economic growth when consumers have higher incomes and they
  can afford to consume more, there is a larger deficit on the current account (they import more)
• If imported raw materials are expensive, there could be cost-push inflation in the UK,
  since firms face higher production costs.

Question 8

Interconnectedness of economies through international trade

Answer 8

If the UK’s main export market, e.g. EU, faces an economic downturn, demand for UK goods and services will fall since consumers in the EU are less able to
afford imports.
International trade has meant countries have become interdependent, so
the economic conditions in one country affect another country, since the quantity they export or import will change.

Question 9

The Current account*

Answer 9

Includes all economic transactions between countries. The main transactions are the trade in goods and services, income and current transfers.

Question 10

Income transfers*

Answer 10

Income transfers are from the net earnings on foreign investment as well as net
cash transfers. They include salaries and dividends.

Question 11

Current transfers*

Answer 11

Transfers that have no return, e.g. aid and grants. It includes the payments the UK makes for being a member of the EU.
- They have traditionally been negative for the UK, due to these contributions and because of overseas aid.

Question 12

The Capital and Financial accounts

Answer 12

Capital transfers involve transfers of the ownership of fixed assets.
The financial
account involves investment e.g. direct investment, portfolio
investment and reserve assets are part of the financial account

Question 13

Causes of a deficit

Answer 13

Appreciation of the currency, Economic growth, More competitive, Deindustrialisation, Membership of trade union

Question 14

Appreciation of the currency*

Answer 14

A stronger currency means imports are cheaper and exports are relatively more expensive, which means the current account
deficit would worsen.

Question 15

Economic growth

Answer 15

When consumer incomes increase, demand increases. This
could increase demand for imports. This is especially true of a country such as
the UK, where consumers have a high propensity to import.

Question 16

More competitive

Answer 16

If a country becomes more internationally competitive, e.g. with lower inflation/if there is economic growth in export markets, exports
should increase. This could cause the current account deficit to improve, or increase the current account surplus.

Question 17

Deindustrialisation

Answer 17

In the UK, the manufacturing sector has been declining since
the 1970s. The goods that the UK previously made domestically now have to be imported, which worsens the deficit.

Question 18

Membership of trade union

Answer 18

The UK has traditionally had negative current
transfers, since fees are paid for membership of the EU.

Question 19

Current, Capital and Financial accounts relationship (deficits and surpluses)

Answer 19

Where there is a current account surplus, there is a capital and financial account deficit. A current account deficit means there will be a capital and financial account surplus.

Question 20

Measures to reduce a country’s imbalance on the current account

Answer 20

1) If there is a deficit on the current account, income tax could be increased, reducing the amount of disposable income consumers have which will reduce the
quantity of imports. However, it might also impact domestic growth, since consumers will also spend less on domestic goods.
2) Fiscal policy could be effective in the short term, but not so much in the long term. As soon as the policy measures end, households are likely to revert their
expenditure back on imports.
3) If taxes are imposed on trading partners, there is the risk of retaliation, which could
reduce demand for exports, too.

Question 21

Significance of global trade imbalances

Answer 21

1) An imbalance suggests that the UK is reliant on the performance of other countries. If export markets, e.g. EU, become weak, UK economic performance will be affected. This was seen during the 2008 financial crisis.
2) In the Eurozone, current account deficits are of greater concern because the countries have a fixed exchange rate, meaning they cannot devalue the currency to restore their level of international competitiveness.
3) A surplus indicates low consumer spending and a low savings ratio. It also means consumers are enjoying fewer goods than they otherwise could, lowering living standards.

Question 22

Current account deficits evaluation - what the significance of global trade imbalance depends upon

Answer 22

The significance depends upon why they have the deficit. For example some countries
may be happy to have a deficit as it allows them to have a financial account surplus
and they may need to import essentials