3.3 The balance of payments

Question 1

The balance of payments

Answer 1

The balance of payment is a record of all money entering the country (debit, +) and leaving the country (credit, -)

Question 2

financial account

Answer 2

The inflows from investments from abroad (debit) against investment to abroad (credit)

Question 3

what are the 3 forms of investments in the financial account?

Answer 3

Direct investment: purchase of long-term assets (such as buildings or factories).
• Portfolio investment: purchases of stocks and bonds.
• Reserve assets: purchases of reserves of gold and foreign currencies.

Question 4

Capital account

Answer 4

income (debit) or expenses (credit) that can’t be placed in any other
category.

• Capital transfers: miscellaneous (e.g. death duties, debt forgiveness).

• Transactions in non-produced non-financial assets: purchases of intangible assets
(trademarks, patents, rights etc.).

Question 5

Current account

Answer 5

Inflows of trade and income (debit) against outflows (credit)

• Balance of trade in goods: exports of goods minus import of goods.
• Balance of trade in services: exports of services minus import of services.
• Income: earnings from investment leaving (-) and entering (+) the country.

• Current transfers: net payments to governments without retribution
(e.g. gifts, aid etc.).

financial account + capital account + net errors &
omissions

Question 6

what are the consequences of A (persistent) current account deficit

Answer 6

1. Downward pressure on the domestic currency exchange rate: more imports than
   exports lead to relatively more supply of than demand for the domestic currency.
2. Increase in indebtedness: to finance the net outflow of money the country must
   borrow money, resulting in more indebtedness and higher interest rates. this can
   result in declining international credit ratings.
3. More foreign ownership of domestic assets: a current account deficit can be financed
   with a financial account surplus, meaning the net ownership of foreign countries
   of domestic country’s assets will increase.

Question 7

What are the methods that a government can use to correct a current account deficit?

Answer 7

1. Expenditure switching methods: making sure people buy more domestic products
   instead of foreign goods so import is reduced. This can be achieved by using
   protectionist measures.
2. Expenditure reducing methods: making sure people spend less in general which will
   also reduce imports. This can be achieved by using contractionary fiscal or
   monetary policy.
3. Supply side policies: boosting supply and therefore exports. This can be achieved using
   expansionary supply side policies.