2.1.4 Balance of payments

Question 1

What are the components of the balance of payments:

Answer 1

• Current account which records payments for the purchase and sale of goods and services
• Capital and financial account which records flows of money, like saving, investment etc

Question 2

What current account does the UK have?

Answer 2

The UK has a current account deficit. This means the UK spends more on imports from foreign countries, than they earn from exports to foreign countries.

Question 3

The relationship between current account imbalances and other macroeconomic objectives

Answer 3

• By selling more exports, the UK will have 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 or recessions, the current account deficit falls. This is because 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
• If imported raw materials are expensive, there could be cost-push inflation in the UK, since firms face higher production costs

Question 4

When do deficits become a problem?

Answer 4

When foreign banks and other lenders refuse to lend money. (credit crunch)

Question 5

When has a ‘credit crunch’ occurred?

Answer 5

• In Mexico in 1982 and Thailand in 1998 and resulted in cutting domestic spending, leading to reduced economic growth and rising employment