2.6.3 The balance of payments

Question 1

Balence of payments

Answer 1

Measures a country’s trasactions with the rest of the world.

Question 1

Current account

Answer 1

= records payments for trade in goods and services plus net flows of primary and secondary income.
= net balance of trade in goods + net balance of trade in services + net primary income + net secondary income.

Question 2

primary income

Answer 2

measures monetary flows generated from owning of cross-boarder financial assets
Inc: income on direct and portfolio investment, tax on wealth and income.

Question 3

secondary income

Answer 3

current transfers between residents and non-residents. Inc: foreign aid, diaspora contributiuons, payments to international instituions.

Question 4

financial account

Answer 4

= measures flow of financial capital into and out of the country.
Inc: net balance of foreign direct investment, NBo portfolio investment flows, balance of banking flows, change to value of country’s reserves.

Question 5

capital account

Answer 5

• Minor component of BoP
• Capital transfers = involves tranfer of assets without exchange of economic value e.g. debt forgiveness.
• Non produced, non-financial asset = sale and purchase of non-financial assets e.g. patents.

Question 6

factors determining exports

Answer 6

• Foreign GDP = as it rises, spending in those countries also increases, leading to greater demand for UK goods and services ∴ rise in exports.
• Productivity = when rises relative to foreign productivity, UK firms can produce more output for a proportionately smaller amount of inputs. Increases efficently - cost per unit falls - allows price to be more competative.
• Inflation = If UK higher than foreign, prices of UK goods rise faster, goods become price competative - lower exports.
• ER= fall makes exports more price competative + imports more expensive to buy in UK.

Question 7

factors determining imports

Answer 7

• UK GDP = as UK income rise, spending will also rise - leads to more being spent on imports.
• Productivity = fall in relative productivity - imports become more desirable.
• Inflation = if higher in UK than other countries, UK goods become less attractive, foriegn goods appear cheaper ∴ more desirable.
• ER = rise will make imports cheaper, possibly more price competative than UK goods.
• Trade barriers = Tarrifs, quotas and protectionist policies effect quantity.

Question 8

Current account deficit

Answer 8

= value of country’s exports are lower than spending on imports.
⤷ net outflow of income from a country’s circular flow.
* Can be sign of economic weakness, means country is relying on borrowing or result of strong economic growth or investment to finance an external deficit e.g. UK needs to attract financial inflows on the financial account.

Question 9

Macro causes of deficit

Answer 9

• Cyclical = when economy experiences a boom - incraese in real income + decrease saving rations - surge in import demand - increase in size of the deficit.
• Structual = focus on supply side weaknesses in an economy such as reliatively decreased production and research and businesses not operating at the cutting edge of innovation.

Question 10

SR causes of deficit (all cyclical)

Answer 10

• Decrease in value of exports.
• Boom in consumer spending - incresaed consumer demand for imported goods and services .
• Strengthening ER
• Broadly based economic boom - increased imported demand.

Question 11

LR causes of deficit

Answer 11

• Decreased rates of capital investment limits overall productive capacity + cost competativeness of key export industies.
• Incraesed cost + price inflation.
• Weak non-price competition
• LT reduction of previously dominent export sectors.

Question 12

Macro policies to improve balence

Answer 12

• Adjusting IR
• Changing the ER
• Altering fiscal policy

Question 13

targeted intervention polcies to improve balence

Answer 13

• Subsidies to exporters.
• Tarriffs on imports
• Direct gov intervention

Question 14

expenditure switching polcies

Answer 14

• Decprecation of ER = reduces export price and imports more expensive, risk of cost-push inflation which would decraese real incomes and standard of living.
• Import tarrifs = incraese price of exports and domestic output - more price competative, risk of retalliation from other countries.
• Low inflation rate = keeps price level under control + exports competative, risk of deflation.

Question 15

expenditure reducing polcies

Answer 15

• Incraesed income taxes = reduces real disposable income - decrases mdemand for imports - cut in living standards and risks causing damage to work incentive.
• Cut in real level government spending = reduces AD, damages to ST economic growth, risks that austerity hits planned business investment.

Question 16

supply side polciies to increase trade

Answer 16

• Infacturcure projects
• Promote enterprise/start ups
• Privatisation
• Investment in eductation
• Protecting property rights
• Tax incentives

Question 17

concequences of deficit

Answer 17

1) Currency weakness - puts pressure on sterling.
2) Slower economic growth - reduces AD
3) Need to attract capital flow

Question 18

reasons for LARGE deficit

Answer 18

1) Export growth weakened.
2) Higher global prices for essential imports.
3) Currency weakness

Question 19

Causes of LARGE deficit

Answer 19

1) Decreased world prices of country’s key exports.
2) Increased value of essential imports.
3) Net outflow of interest, profts + dividends from stock of foreign investment.

Question 20

J curve

Answer 20

= shows possible time lag between decreased currency and incraesed time lag.
* Describes ST impact of deprecation in a coun try’s currency on it’s trade balance, may not improve current account/trade account - due to elasticities of demand for export and imports likely to be inlastic in ST.
* Takes time for export businesses to increase sales after decreasing price.
* Earnings from selling exports may be insufficent to compensate for increasing total spending on imports ∴ balance of trade may initially worsen.

Question 21

marshal-lerner condition

Answer 21

= a deprecation/ devaluation of ER will lead to net improvement in trade balance, provided that sum of PED for exports and imports > 1.

Question 22

current account surplus

Answer 22

= volume of exports of all goods and services exceed the volume of imports of all goods and services.
* Net injection of income into a country’s circluar flow.
* Surplus nations kown as crediter countries, leads to accumilation of foreign exchange.

Question 23

causes of surplus

Answer 23

• External surplus = country building stong competitative advantage in range of industries.
• Persistant surplus of saing s over investment leads to demand for exports becomes weaker.
• Export surplus = high world prices for exports of any comodities.
• String net inflows of investment income.

Question 24

effects of surplus

Answer 24

• Increased AD = leads to positive output gap and causes demand pull inflation.
• Resource constraints = price rises, contributing to cost-push inflation.
• Asset price inflation = prices of assets rise rapidly.

Question 25

advantages of surplus

Answer 25

• Increase in national saving, allows reduction of internal debt and overseas investment.
• Net inflow of demand into the circular flow e.g. profits from overseas investment sprovide flows of funding for corporate investment.

Question 26

risks/ disadvantage of surplus

Answer 26

• Appreciation of currency, some domestic businesses less competative.
• Invite a protectionist response, may get locked into a trade war.

Question 27

importance of BoP

Answer 27

• Economic stability
• ER stability
• Sustainable growth
• Trade and export competativeness
• Foreign exchange reserves
• Poverty reductions

Question 28

trade imbalences

Answer 28

= occour when some countries run persistant surpluses on their trade accounts, whereas others experience persistant and often large external deficits.
⤷ Significance of large internal deficits = reliant of foreign capital which risks political opposition and domestic assets, surpluses cause depressing global AD + growth.