4.2 Balance of payments

Question 1

Define balance of payments

Answer 1

The record of all financial transactions between one country and the rest of the world

Question 2

Define balance of payments on current account

Answer 2

The total of net trade in goods and services, income flows and transfers between one country and the rest of the world

Question 3

Define current account

Answer 3

The record of trade in goods and services, income flows and transfers between one country and the rest of the world

Question 4

Define balanced current account

Answer 4

Where the sum of exports plus the inflow of income and transfers is equal to the sum of imports plus the outflow of income and transfers

Question 5

Define a current account surplus

Answer 5

Where the sum of exports plus the inflow of income and transfers is greater than the sum of imports plus the outflow of income and transfers

Question 6

Define current account deficit

Answer 6

Where the sum of exports plus the inflow of income and transfers is less than the sum of imports plus the outflow of income and transfers

Question 7

Why may a current account deficit be important?

Answer 7

• If it is caused by problems in the economy, such as falling total demand for domestic goods, which can be caused by lower international competitiveness and poor product quality
• If it is large in size, this is harder for a country to be able to finance and increases national debt more significantly. It also has bigger consequences such as higher unemployment
• If the country may then need to take action that is harmful, e.g. cutting other government spending which may have an opportunity cost

Question 8

Why may a current account deficit not be important?

Answer 8

• If it is only temporary (e.g. due to importing raw materials or capital goods to put into the production of goods that will eventually be exported and increase economic growth)
• If over time, it leads to a fall in the exchange rate, which can increase the international competitiveness of UK goods and eventually increase exports
• If it is only a small percentage of GDP so the debt can be paid for by the country with less difficulty

Question 9

Why may a current account surplus be important?

Answer 9

• If it reflects rising total demand for domestic goods, which can be linked to decreased unemployment, more income tax revenue and lower benefit payments
• If it decreases the debt of a country because more money is flowing into the country from greater spending on exports than money flowing out for imports

Question 10

Why may a current account surplus not be important?

Answer 10

• If it causes rising inflation within the domestic country: as exports are greater than imports, therefore increasing the total demand for domestic products and putting upwards pressure on prices
• If it leads to a rise in the exchange rate, which can decrease the international competitiveness of UK goods and eventually decrease exports

Question 11

What causes a surplus of the current account?

Answer 11

• A lack of growth in the domestic economy: consumers within the economy may buy fewer imports, while domestic firms, finding it difficult to sell at home, compete more to sell exports abroad
• A fall in the exchange rate, which may increase the quantity of exports if overseas consumers are responsive to the now lower export prices.

Question 12

What causes a deficit of the current account?

Answer 12

• Structural problems in the economy (e.g. firms overpricing goods, producing poor-quality goods or goods no longer in demand)
• Falling income overseas, which may lead to falling exports
• Rising incomes in the domestic economy may lead to rising imports