4.3.3 Balance of Payments and Exchange Rates

Question 1

What is the Balance of Payments?

Answer 1

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

Question 2

Respectively, what are inflows and outflows of currency to/from the balance of payments referred to as?

Answer 2

Positive and Negative Entry

Question 3

What is the Current Account?

Answer 3

Where payments for the purchase and sale of goods and services are recorded

Question 4

What is the Current Account comprised of?

Answer 4

• Trade in Goods Balance
• Trade in Services Balance
• Investment Income Balance
• Current Transfers

Question 5

What is the ‘investment income balance’ in the Current Account?

Answer 5

Income from assets owned overseas - income paid to foreign investments in the UK

Question 6

What is the Capital and Financial Account?

Answer 6

Where flows of money associated with saving, investment, speculation and currency stabilisation are recorded.

Question 7

What takes place in the Capital Account?

Answer 7

Financial capital that enters or leaves the country along with immigrants/emigrants who take it with them

Question 8

What is recorded in the Financial Account ?

Answer 8

• Foreign Direct Investment
• Portfolio Investment
• ‘Other’ Investments

Question 9

What is Foreign Direct Investment?

Answer 9

Flows of money to purchase a controlling interest in a firm (at least 10% of shares)

Question 10

What is portfolio investment

Answer 10

Flows of money to purchase foreign shares which amount to less than 10% of overall shares/voting power

Question 11

What are ‘other investments’ in the financial account apart from FDI and Portfolio investment?

Answer 11

• Trade Credit
• Loans
• Purchases of Currency
• Bank Deposits

Question 12

What are the reasons for international capital flow?

Answer 12

• Currency Speculation
• Loans by Banks to finance loans to households
• Profitability of short term loans to economic agents in other countries

Question 13

What are the economic advantages of International Capital Flows?

Answer 13

• Facilitates growth in world trade by financing it
• Provides Capital for firms that cannot get finance for it domestically
• Leads to sharing of technology between nations. FDI is the best way for LEDCs to get modern tech

Question 14

What are the disadvantages of International Capital Flows?

Answer 14

• 2008 Financial crisis showed vulnerability of global financial system to problems
• Threats to national security if other countries own significant industries in UK
• Encourages firms/countries to overborrow increasing risk of financial crisis

Question 15

What are the causes of Surpluses and Deficits in the Current Account?

Answer 15

• Natural Resources
• Underlying Competitiveness
• Exchange Rates
• Inflation
• Investment and long term economic growth
• Spending by consumers and governments

Question 16

How are natural resources a cause of current account imbalance?

Answer 16

Some countries have abundant natural resources relative to population size, so they have a lot to export but not a lot of people importing

Question 17

How is underlying competitiveness a cause of current account imbalance?

Answer 17

Good international competitiveness means more exports so more surplus.
Bad competitiveness means less exports so more deficit.

Question 18

How are exchange rates a cause of current account imbalance?

Answer 18

Some countries manipulate their exchange rates to stay low to keep exports cheap, leading to surplus. Other keeps exchange rates high in order to have cheap imports but leads to deficit

Question 19

How does inflation affect current account imbalances?

Answer 19

high inflation rates damage price competitiveness, decreasing exports and leading to deficit.
Lower relative inflation improve price competitiveness and lead to increased imports and lead to surplus

Question 20

How are investments and long term economic growths factors to determine current account imbalances?

Answer 20

• Large amounts of FDI flowing into a country means deficit

- New exporters of capital typically mean surplus

Question 21

How is spending by consumers and governments link to current account imbalances?

Answer 21

-Too much spending linked to deficits because of the need to borrow internationally to finance