4.1.7 balance of payments

Question 1

Components of the balance of payments:
the current account

Answer 1

definition - record of the value of imports and exports and international transfers

consists of trade in goods and services and primary (investment income) and secondary income (current transfers)

Question 2

Components of the balance of payments:
the capital and financial accounts

Answer 2

definition - record of the purchase and sale of assets

financial account
- this includes transactions that result in a change of ownership of financial assets
- FDI flows, portfolio flows including gov bonds, banking flows

capital account
- Sale/transfer of ownership of fixed assets, patents, copyrights, franchises, leases and other transferable contracts, and goodwill

Question 3

causes of current account deficits and surpluses

Answer 3

• high levels of consumer demand (deficit)
• strong exchange rate (deficit)
• relative inflation rate (deficit)
• if a country is losing its comparative advantage (deficit)
• lack of capital investment leading to lack of productivity (deficit)
• deindustrialisation of export industries (deficit)
• natural resources tend to export more (surplus)
• more competitive (surplus)
• corruption (deficit)

Question 4

effects of current account deficits

Answer 4

• lower AD
• increase in unemployment
• demand pull inflation will decrease
• weaker exchange rate; could lead to currency and economic crisis if deficit is large and persistent
• weaker currency will push up import costs resulting in cost push inflation

however deficit may not necessarily be anything to worry about in economic booms as consumers spend more on everything

Question 5

Measures to reduce a country’s imbalance on the current account

Answer 5

expenditure reducing policies
- designed to control demand and limit spending on imports - squeeze on demand, encouraging rising private sector saving
- deflationary policies

expenditure switching policies
- designed to change the relative prices of exports and imports - this causes changes in spending away from imports and towards domestic/export production
- exchange rate changes (eval - marshal Lerner condition/ J curve, not feasible due to floating ER)
- protectionism

Improving the supply-side performance of the economy to boost competitiveness, economic reform is a long-run strategy

Improving macroeconomic stability to make a country more attractive to inward investment, investment can raise productivity and increase a country’s capacity for exporting

CANNOT SOLVE LONG TERM CAUSES OF A DEFICIT

Question 6

Significance of global trade imbalances

Answer 6

• argued that surplus isn’t as much of a problem but the financial crisis of 2008 drastically reduced capital flows around the global economy
• if a country has a constant surplus, it will tend to build up a stock of assets abroad whilst a constant deficit will mean they owe more and more to foreign creditors
• today, deficits are less of a concern to countries, the ​US and UK have no problem financing their deficits and borrowing has not built up unsustainable debts
• current account imbalances become a problem when governments can’t repay their foreign currency debts
• current account surpluses cause losses for citizens in a country who don’t see the high living standards which they could enjoy from consuming more