4.1.7 Balance of Payments

Question 1

what is the balance of payments

Answer 1

a summary of all transactions between one country and the rest of the world over a year

Question 2

what does the balance of payments consist of

Answer 2

current account
capital account
financial account

Question 3

what is the current account

Answer 3

the sum of a country’s balance on trade in goods and services, net income from abroad and net current transfers

Question 4

what are the sub sections of the current account

Answer 4

TRADE BALANCE
-trade in goods
-trade in services

-primary income- uk earning from overseas assets minus payments made to foreign owners of uk assets
-secondary income- money transfers between governments

Question 5

What does the financial account consist of

Answer 5

FDI
Reserve assets

Question 6

How are current accounts deficits financed

Answer 6

It needs to attract net financial flows on the financial account
-investors buying UK property or stocks
-hot money flows when interests rise
-UK businesses sell overseas assets
-overseas investors buy gov debt in bond market

Question 7

What is a cyclical current account deficit

Answer 7

Short term
When there is a boom, there is an increase in import demand due to increased incomes and consumer spending so the trade deficit increases

Question 8

What is a structural current account deficit

Answer 8

Long term
When low research and investment, capital investment and productivity means exports are less competitive as they are worse quality and more expensive

Question 9

Why can current account deficits be concerning

Answer 9

-can cause a fall in AD which impacts the macroeconomic objectives
-indicates a lack of international competitiveness
-weakens the exchange rate so could cause cost push inflation

Question 10

Why might a current account deficit not be concerning

Answer 10

-sign of economic growth (high consumer confidence and spending = demand for imports so AD shifts out)
-common for LEDC’s as they grow

Question 11

What causes a current account deficit in the short run

Answer 11

-fall in the value of exports possibly due to decline in price of a country’s major export (LEDC’s especially affected)
-increase in consumer spending (increased import demand)
-strengthening of the exchange rate (exports are less competitive)

Question 12

What are some long run causes of a current account deficit

Answer 12

Affect LRAS
-low capital investment
-high inflation
-weakness in non-price competition
-decline of dominant industries e.g steel

Question 13

How can an economic boom cause a current account deficit and a piece of evaluation

Answer 13

Real incomes rise - consumption increases - imports increase - trade deficit widens

Likely to be short term

Question 14

How can a strong currency cause a current account deficit and an evaluative comment

Answer 14

Currency appreciates - export prices rise - exports are less competitive - value of exports fall
= worsens trade deficit
- imports are cheaper - demand for imports rises - value of imports fall

Depends on import PED

Question 15

How can low productivity cause a current account deficit

Answer 15

Low productivity - high wage costs - higher cost of production - less competitive - exports fall - trade deficit worsens

Question 16

What are the expenditure switching policies to improve the current account and an evaluative comment (3)

Answer 16

Depreciation of the exchange rate - reduces exports prices and makes imports more expensive
-risk of cost push inflation which could increase costs of production and cause prices of exports to rise

Import tariffs - increases the price of imports
-risk of retaliation

Low rate of inflation - makes exports more competitive
-risks from deflation

Question 17

What are the expenditure reducing policies to improve the current account and an evaluative comment (2)

Answer 17

Increase income tax - reduces real disposable incomes - fall in demand for imports
-reduced living standards and could cause a brain drain or reduced FDI

Cut in gov spending - lowers AD so firms may look to export to make more use of spare capacity
-damages short term growth

Question 18

What are some supply side policies to improve the trade balance

Answer 18

Infrastructure projects - improvements to transport and telecoms = increase in supply-side capacity
Privatisation and deregulation
Education - improve human capital
Tax incentives - attract FDI

Question 19

What is the Marshall-Lerner condition

Answer 19

Depreciation of a currency will improve the current account if the combined elasticities of demand for exports and imports are greater than one

Question 20

What is the J-curve effect

Answer 20

It shows the possible time lags between a falling currency and an improved trade balance

Question 21

If the combined PED of imports and exports is 1 will a fall in currency improve the trade balance

Answer 21

It will be unchanged

Question 22

If the combined PED of imports and exports is less than 1 will a fall in currency improve the trade balance

Answer 22

No it will worsen

Question 23

If the combined PED of imports and exports is greater than 1 will a fall in currency improve the trade balance

Answer 23

Yes

Question 24

Explain the J curve effect

Answer 24

1. A currency is depreciated
2. Trade deficit may grow initially as PED for exports and imports being inelastic (less than 1) in the short run
3. Net improvement in trade over time provided the Marshall-Lerner condition is met