3.3 Balance of payments

Question 1

What is the role of the balance of payments?

Answer 1

The balance of payments of a country us ‘a record (usually for a year) of all transactions between the residents of the country and the residents of all other countries’

Question 2

What are the accounts on the balance of payments?

Answer 2

• Current account
• Captial account
• Financial account

Question 3

What does the current account represent?

Answer 3

• Balance of trade in goods
• Balance of trade in services
• Factor rewards/income (wages, rents, interest, profit)
• Current transfers (e.g. foreign aid)

[it is the largest]

Question 4

What does the capital account represent?

Answer 4

• Net capital transfers (e.g. debt forgiveness)
• Non-produced, non-financial assets (e.g. intellectual property, fishing rights)

[it is the smallest]

Question 5

What does the financial account represent?

Answer 5

• (FDI) Direct investment (physical capital e.g. factories)
• Portfolio investment (e.g. stocks & bonds)
• Reserve assets (e.g. foreign currency)

Question 6

What is credit?

Answer 6

Money/value “paid in” on a country’s account

Question 7

What is debit?

Answer 7

Money/value “paid out” on a country’s account.

Question 8

If there is a debit on the current account, how does this affect the currency?

Answer 8

It would cause a surplus of the currency, which would cause depreciation.

Question 9

If there is a credit on the current account, how does this affect the currency?

Answer 9

It would cause a shortage of the currency, which would cause appreciation.

Question 10

If credits > debits, how do we describe the current account?

Answer 10

There is a current account surplus.

Question 11

If credits = debits, how do we describe the current account?

Answer 11

There is a balance of the current account.

Question 12

What must equal on the balance of payments?

Answer 12

Current account + capital account + financial account + net errors and omissions = 0

Question 13

How does the balance of payments correct in a free-floating exchange rate system?

Answer 13

Automatically (through market forces)

Question 14

How does the balance of payments correct in a fixed exchange rate system?

Answer 14

Requires intervention by the government and/or central bank.

Question 15

How are the current account and financial account related?

Answer 15

A current account deficit balances with a financial account surplus.

E.g. Appreciation that has caused a current account deficit (X-M), might cause direct investment to increase.

Question 16

If there is depreciation and imports are PED inelastic, how would this impact debits/credits on the current account?

Answer 16

Increase debits

Question 17

If there is depreciation and imports are PED elastic, how would this impact debits/credits on the current account?

Answer 17

Decreases debits

Question 18

If there is depreciation and exports are PED inelastic, how would this impact debits/credits on the current account?

Answer 18

Decreases credits

Question 19

If there is depreciation and exports are PED elastic, how would this impact debits/credits on the current account?

Answer 19

Increases credits

Question 20

If there is appreciation and imports are PED inelastic, how would this impact debits/credits on the current account?

Answer 20

Decreases debits

Question 21

If there is appreciation and imports are PED elastic, how would this impact debits/credits on the current account?

Answer 21

Increases credits

Question 22

If there is appreciation and exports are PED inelastic, how would this impact debits/credits on the current account?

Answer 22

Increases credits

Question 23

If there is appreciation and exports are PED elastic, how would this impact debits/credits on the current account?

Answer 23

Decreases credits

Question 24

What happens to a trade deficit/surplus when the PED of imports and exports sum to above 1, during depreciation?

Answer 24

Depreciation would cause a trade deficit to decrease

or a trade surplus to increase.

Question 25

What happens to a trade deficit/surplus when the PED of imports and exports sum to below 1, during depreciation?

Answer 25

Depreciation would make a trade deficit larger

or a trade surplus smaller

Question 26

What happens to a trade deficit/surplus when the PED of imports and exports sum to exactly 1, during depreciation?

Answer 26

Depreciation would leave the trade balance unchanged

Question 27

What is the Marshall-Lerner condition?

Answer 27

Even if PED_M < 1 and/or PED_X < 1, as long as the sum to above 1, depreciation will improve a trade deficit.

Question 28

How does the Marshall-Lerner condition look graphed?

Answer 28

Trade balance (X-M) on the y-axis and time on the x-axis.

Starting in a trade deficit, the line is flat (time lags/menu costs), it then briefly goes downwards, as the PED sum is below one, however, once the sum is above one the line curves upwards and goes into a trade surplus.

Question 29

How can a PPF diagram show a trade surplus?

Answer 29

A country consumes at a point well within its PPF

Question 30

How can a PPF diagram show a trade deficit?

Answer 30

Consumption is a point beyond the PPF.

Question 31

If credits

Answer 31

There is a current account deficit.