4.1.7 Balance of Payments

Question 1

Components of current account on balance of payments?

Answer 1

• Trade in goods and services
• Primary and secondary income

Question 1

Components of financial account on BoP?

Answer 1

• Net balance of FDI
• Net balance of portfolio investment flows
• Balance of banking flows
• Changes to value of country’s reserves of gold and foreign currency

Question 2

Components of capital account on BoP?

Answer 2

• Capital transfers
• Non-produced, Non-financial assets (e.g. land ownership, patents and licenses)

Smallest part of BoP

Question 3

Advantages of international capital flows for the world economy?

Answer 3

• Facilitates world trade
• Additional source of finance for firms
• FDI could lead to transfer of skills and technology

Question 4

Causes of current account deficits/surpluses?

Answer 4

• Relative export competitiveness (inflation, productivity, R+D)
• Exchange rate
• State of economy

Question 5

Problems with a current account deficit?

Answer 5

• AD reduced (but depends on size of deficit and causes of deficit)
• Debt burden ↑ = amount of borrowing ↑ (but depends on how sustainably current account is financed)

Question 6

Problems with a current account surplus?

Answer 6

• Indicative of heavy reliance on exports (depends on size of surplus, could be result of successful SSPs)
• Can be detrimental to trade partner economies (depends on level of AD in trade partner’s economies - more likely to be a problem during recessions or when theres limited fiscal space*)

*Limited fiscal space = situation where cant raise taxes or cut spending

Question 7

Methods to reduce current account deficit?

Answer 7

• Expenditure reducing policies (e.g. contractionary monetary/fiscal policy) - for ↓AD = ↓income = ↓spending on imports

Expenditure switching policies:
* Protectionism (e.g. tariffs, quotas, embargos, admin barriers, subsidies): - ↑export competitiveness = ↑exports and ↓imports
* Weaker exchange rate (lower IR, increase money supply, sell domestic currency reserves): - for cheaper exports = ↑exports
* SSPs (e.g. infrastructure spending, education + training, tax cuts): - for ↑productivity = ↑quality of exports = exports > imports

Question 8

Evaluate expenditure reducing policies?

Answer 8

Contractionary monetary/fiscal policy
* Recession
* MPM
* Business/consumer confidence
* Level of output gap

Question 9

Evaluate protectionism policy

Expenditure switching policy

Answer 9

• Retaliation
• Could break WTO rules
• Inflationary
• Higher prices for domestic consumers

Question 10

Evaluate weaker exchange rate

Expenditure switching policy

Answer 10

• Inflationary due to ↑import prices
• Trading partners could weaken exchange rates in response

Question 11

Evaluate SSPs

Expenditure switching policy

Answer 11

• Time-lag
• Cost
• No guarantee of success