4.1.7 Balance of Payments 1

Question 1

Balance of payments

Answer 1

a record of all a country’s financial dealings with the rest of the world over the course of a year

Question 2

Components of the balance of payments

Answer 2

• The current account
• Capital account
• Financial account
• International investment

Question 3

Components of the current account

Answer 3

• Balance of trade (trade of goods & services)
• Income
• Current transfers

Question 4

Capital account

Answer 4

records all capital transfers & net acquisitions or disposal of non-produced, non-financial assets

Question 5

Financial account components

Answer 5

• direct investment
• portfolio investment
• financial derivatives
• reserve assets

Question 6

Balance of trade

Answer 6

the difference between the value of g/s exported & value of g/s imported
- exports = money into country = a positive entry into the balance of payments - UK has £25 bn deficit

Question 7

Income

Answer 7

income earned by domestic citizens who own assets overseas minus income earned by foreign citizens who own asset in this country
- includes profits, dividends on investments aborad & interest

Question 8

Current transfers

Answer 8

money transfers between central govt (who lend & borrow money from each other) or grants, such as those that the UK receives as part of the CAP from the EU

Question 9

Current account deficit

Answer 9

the value of money leaving the country exceeds the value of money entering the country

Question 10

Current account surplus

Answer 10

the value of money entering the country exceeds the value of money leaving the country

Question 11

Financial account

Answer 11

transactions associated with changes of ownership of the UK’s foreign financial assets & liabilities

Question 12

Direct investment

Answer 12

capital provided to or received from an enterprise, by an investor in another country

Question 13

Portfolio investment

Answer 13

investments in equities & debt securities

Question 14

Financial derivatives

Answer 14

any financial instrument the price of which is based upon the value of an underlying asset
- include trade financial futures, warrants & currency & interest

Question 15

Reserve assets

Answer 15

foreign financial assets that are available to & controlled by the monetary authorities such as the BoE for financing or regulating payments imbalances
- e.g monetary gold, special drawing rights, reserve position in the IMP, foreign exchange held by the Bank

Question 16

International investment position

Answer 16

the balance sheet of the stock of external assets & liabilities

Question 17

Why must balance of payments balance?

Answer 17

• If a country has a current account deficit, it must have a surplus on the other elements of the balance of payments. This is because it has to pay for everything it consumes & funds in some ay- to fund a current account deficit, a country must be selling assets to foreign investors
• this might sustainable in the long run since if ppl invest in a country, at some point, they will require a return on their investment & they will cause a deficit on the financial account

Question 18

Are global imbalances significant?

Answer 18

• since a country’s balance of payments must always balance, any global imbalances are insignificant. However, the Global Financial Crisis of 2008 suggests the persistently large current account deficit may be unsustainable in the long run

Question 19

Are global imbalances significant? (yes)

Answer 19

• large & persistent deficits can be a problem bc there is need to finance the increasing expenditure on imports, usually through loans from abroad

Question 20

Are global imbalances significant? (yes) 2

Answer 20

• large & persistent deficits can be a problem bc resources are focused on producing to meet export demand rather than domestic demand so consumer choice & living standard decreases
• imbalances = large currency fluctuations = instability of world

Question 21

Why might UK be running a persistent deficit on the current account?

Answer 21

• Wages
• Investment
• High consuming spending
• Less competitive

Question 22

Why might UK be running a persistent deficit on the current account? (wages)

Answer 22

UK firms pay UK workers abroad = outflow of money.
- The outflow to UK workers > inflows to foreign workers in UK

Question 23

Why might UK be running a persistent deficit on the current account? (investment)

Answer 23

• decrease in direct investment income

Question 24

Why might UK be running a persistent deficit on the current account? (high consumer spending)

Answer 24

increased deficit, low saving

Question 25

Why might UK be running a persistent deficit on the current account? (less competitive)

Answer 25

increase wage costs, poor quality = decreased competitiveness

Question 26

Current account surplus example

Answer 26

• Norway- current account surplus is 15% of GDP
• exporting energy (oil and gas)

Question 27

Current account surplus example 2

Answer 27

Ireland- current account surplus of 13.9% of GDP
- low corporation tax (12.5%) compared to over 20% in other European countries