4.1.7 Balance of Payments 2

Question 1

Causes of a persistent deficit on the current account

Answer 1

• supply-side deficiencies
• high propensity to import
• relatively low investment
• exchange rate
• Marshall-Lerner condition
• poor productively
• trade

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Question 2

Causes of a persistent deficit on the current account (supply-side deficiencies)

Answer 2

• poor infrastructure or skills base = poor quality & design

Question 3

Causes of a persistent deficit on the current account (high propensity to import)

Answer 3

e.g UK. If real incomes rise by £1, 60p is spent on imported items
- MPM = 60p

Question 4

Causes of a persistent deficit on the current account (relatively low investment)

Answer 4

relatively low investment (R&D) or slow application of tech
- e.g in 2021, business investment accounted for 10% of GDP

Question 5

Causes of a persistent deficit on the current account (exchange rate)

Answer 5

• a high value of a country’s currency
• In Sept, British pound fell to $1.04 (compared to $2.50 in 1970s)

Question 6

Causes of a persistent deficit on the current account (marshall-lerner)

Answer 6

Marshall- Lerner condition is not met
- suggests the devaluation of country’s currency = an improvement in its balance of trade if the sum of the price elasticities of its exports & imports is greater than 1
- ie the sum of the PED for M+X is price inelastic, a decreased in £ value worsens the deficit

Question 7

Causes of a persistent deficit on the current account (productivity)

Answer 7

• relatively poor productivity
• e.g France is around 18% more productive than the UK

Question 8

Causes of a persistent deficit on the current account (trade)

Answer 8

• globalised trading/imports & global free trade promotion (allocative efficiency gains to consumer)/openness to trade as a positive
• e.g trade blocs NAFTA- CANADA, US & Mexico

Question 9

Measures to correct current account deficit

Answer 9

• supply side policies
• expenditure switching policies (use of protectionist measures
• expenditure reducing policies - measures designed to reduce AD-macro

Question 10

Measures to correct current account deficit (supply-side policies)

Answer 10

increased spending on education & training to increase quality so increased competitiveness of exports
- positive: contribute positively to econ growth & c an be anti-inflationary
- negative: incur an opportunity cost

Question 11

Measures to correct current account deficit (expenditure-switching policies)

Answer 11

(use of protectionist measures)
- exchange rates
- tariffs of quotas
- devaluation

Question 12

Measures to correct current account deficit (expenditure-switching policies: devaluation)

Answer 12

a devaluation of the currency under a fixed exchange rate regime (monetary policy- money supply increased to lower currency value and boost X, and decreased M
- devaluation = decreased deficit
- also decreased consumer spending = decreased deficit

Question 13

Measures to correct current account deficit (expenditure-reducing policies)

Answer 13

measures designed to reduce AD
- Monetary policy: raise interest rates = decreased AD including import reduction
- Deflationary fiscal policy: e.g increases in taxation to decrease demand = decrease imports

Question 14

Does a current account deficit matter (yes)?

Answer 14

• structural deficits
• sales of UK firms overseas
• dependence on foreign creditors

Question 15

Does a current account deficit matter (yes- structural deficits)?

Answer 15

• structural deficits imply a lack of global competitiveness/productivity falling in the UK economy

Question 16

Does a current account deficit matter (yes- sales overseas)?

Answer 16

• concerns over sales of UK firms to overseas buyers (Heritage brands & security concerns)

Question 17

Does a current account deficit matter (yes- dependence on foreign creditors)?

Answer 17

• If attitudes to an economy changes, investors might lose confidence & country might not be able to attract enough foreign capital
• e.g FDI/purchase of UK assets e.g gilts. UK relying on inflow of foreign money since 1955
  If UK can’t attract foreign inflows
• UK interest rates need to increase to attract ppl. Increase interest rates = decreased demand
• pound devalues = inflationary pressure.
  This could result in recession

Question 18

Does a current account deficit matter (no)?

Answer 18

• might be small relative to size of economy
• cyclical deficit
• imports may be of capital goods

Question 19

Does a current account deficit matter (no- might be small relative)?

Answer 19

• might be small relative to the size of the economy. If the rate of econ growth is faster than the ratio of ca deficit to GDP growth, we can carry it
• depends on scale & extent of the deficit

Question 20

Does a current account deficit matter (no- might be small relative) example?

Answer 20

• Iceland = unsustainable. Shows a lack of competitiveness in Eurozone
• e.g UK’s deficit is 3.7% of GDP. Iceland in 2005 was 23% of GDP

Question 21

Does a current account deficit matter (no- cyclical deficit)?

Answer 21

• cyclical deficit will self-correct as economy moves from boom to downturn
• Boom = import volumes & values are high = X more competitive = M cheaper

Question 22

Does a current account deficit matter (no- imports of capital goods)?

Answer 22

• imports may be of capital goods = good for the economy
• long term capital inflows = inward investment = future improvements
• easy to do due to globalisation = easier to attract sufficient capital to finance deficit
  e.g UK interest rates are low. 10 year borrowing = 3%