4.1.7 Balance of payments

Question 1

Balance of payments

Answer 1

The record of a country’s inflows and outflows of money.

Question 2

What is the current account of balance of payments?

Answer 2

The main part of the balance of payments that is needed for the exam is the current account, which records the international exchange of goods and services.

Question 3

What does the current account of balance of payments consist of?

Answer 3

• Trade in goods, often called ‘visible trade’ – these include visible imports or visible exports. | Examples: cars, computers, food
• Trade in services, often called ‘invisible trade’ – these can be exported or exported too. | Examples: tourism, insurance, legal services, transport.
• International flows of income earned as salaries, interest, profit and dividends. | Examples: interest on an account help in a foreign country or dividends from a company based abroad.
• Transfers of money from one person or government to another. | Examples: foreign aid, transfer of money to or from a family member who lives in another country.

Question 4

What is it called if the balance of payments isn’t balanced?

Answer 4

• Surplus: If the money flowing in exceeds the money flowing out.
• Deficit: If the money flowing out exceeds the money flowing in.

Question 5

Does the UK have a surplus or deficit in its balance of payments?

Answer 5

Deficit

Question 5

Does the UK have a surplus or deficit in its balance of payments?

Answer 5

Deficit

Question 6

Consequences of a deficit in the balance of payments

Answer 6

• It could indicate that an economy is uncompetitive.
• A deficit isn’t always a bad thing – it might mean that people in that country are wealthy enough to be able to afford lots of imports. A deficit may also allow people to enjoy a higher standard of living, as they’re importing the things they want and need. But, a long-term deficit is likely to cause problems.
• The consequences of a deficit include a fall in the value of a currency, leading to higher import prices (in the short run). This can lead to an increase in inflation.
• A balance of payments deficit may also lead to job losses domestically. For example, if more goods are being imported that may mean fewer goods need to be produced domestically, so unemployment may increase.

Question 7

Causes of a balance of payments deficit

Answer 7

1) It is struggling to compete internationally.
2) There are high levels of consumer spending (low savings rate).
3) It has to deal with external shocks.

Question 8

Causes of a balance of payments surplus

Answer 8

1) It has been experiencing a recession - sometimes domestic producers will struggle to sell products domestically, so they’ll focus their efforts of competing in international markets instead.

2) Its domestic currency has a low value – this will make exports cheaper and imports more expensive.

3) High interest rates are causing more saving and less spending.

Question 9

Consequences of a surplus in the balance of payments

Answer 9

• It could indicate that an economy is competitive.
• However, if a country has a surplus for a prolonged period of time, they may experience stagnation.
• This means that the country will be experiencing low AD and therefore low (or even negative) economy growth – which also has the potential to lead to other problems such as high unemployment.
• A large current account surplus may also be as a result of an economy’s overreliance on exports.
• If a surplus is created by a country having an undervalued currency, this will create inflation – with price of imported factors of production will rise, meaning a rise in the costs of production and therefore a rise in the price level.

Question 10

Stagflation

Answer 10

A stagnant economy with low growth and unemployment with high inflation.