4.6 Balance Of Payments

Question 1

What is the balance of payments

Answer 1

A record for all transactions between residents of the country and the residents of all other counties

Question 2

What is a deficit and a surplus in BOP

Answer 2

Surplus in an account occurs when balance has a positive value, meaning that credits are lager than debits

Deficit in an account occurs whenever a balance has a negative value, meaning that debits are larger then credits

Question 3

What are credits

Answer 3

All payments received from other countries

Question 4

What are debits

Answer 4

All payments made to other countries

Question 5

Components of BOP

Answer 5

Current account

Capital account

Financial account

Question 6

Elements of the current account (4)

Answer 6

Balance of trade in goods - exports are a credit ; imports are a debit

Balance of trade in services - tourism to a country is a credit ; tourism to another country is a debit

Income - income made from abroad sent back to country is a credit - income sent abroad is a debit

Current transfer - money sent home to relatives is a debit; money received from abroad is credit

Question 7

What does a deficit mean for the current account

Answer 7

There is an excess supply of the currency in the foreign exchange market

Question 8

Components of capital accounts

Answer 8

Capital transfers - inflows minus outflows for things such as debt forgiveness, investment grants etc

Transaction in non-produced, non-financial assets - purchase or use of natural resources that have not been produced

Question 9

What does a surplus in the capital account suggest

Answer 9

There is an excess demand of the currency in the foreign exchange market

Question 10

Components of the financial account

Answer 10

FDI - inflow of FDI, credit ; outflow of FDI, debit

Portfolio investment - inflows for purchase of stocks and bonds, credit ; outflow for purchase, debit

Reserve assets - selling currency to purchase domestic currency, is credit ; buying currency by selling domestic currency, is debit

Official borrowing - inflow of funds from governments abroad, is credit ; lending to other countries, is debit

Question 11

Interdependence between accounts what must they all sum up to

Answer 11

Zero; sum of all credits always balance with the sum of all debits

Question 12

Relationship between current and financial account

Answer 12

A current account deficit means country consumes more then it produce ; therefore paying for extra output consumed through a financial account surplus

Question 13

Relationship between current account and exchange rates

Answer 13

deficit in current account implies excess supply of currency due to decrease demand for exports — downward pressure on ER - deprecation

surplus in the current account , implies increased demand for exports - market forces create upward pressure on ER (appreciation)

Question 14

Graph for relationship between current account DEFICIT and exchange rates

Answer 14

Question 15

Graph for relationship between current account SURPLUS and exchange rates

Answer 15

Question 16

Relationship between financial account and ER

Answer 16

• country with financial surplus experiences high inflation - central bank purse contraction are monetary policy by increasing interest rates
• Attract inflow of financial capital and additional credits in the financial account correspond to increased currency demand
• Fall in currency supply as domestic investors now prefer financial investments in the domestic market
• More credits with fewer debts result in excess credits - excess of current demand over supply - appreciation of the currency of the county

Question 17

Implications of persistent current account deficits

Answer 17

• depreciating exchange rate
• Need for higher interest rates to attract foreign financial investments
• Foreign ownership of domestic assets
• Increasing levels of debt
• Cost of paying interests on loans
• Fewer imports of needed capital goods
• Poor international credit ratings
• Lower economic growth
• Lower standard of living in future

Question 18

Policies to correct persistent current account deficits

Answer 18

• expenditure reducing policies

• expenditure switching policies

• supply side policies

Question 19

Explain expenditure reducing policies

Answer 19

• contractionary fiscal and monetary policies reduce AD - lower demand for imports
• combination of fewer imports and more experts may work to reduce the current account deficit
• however may create a recession - also risk of that high interest rates leads to current appreciation - discourage exports and encourage imports - canceling out beneficial effects

Question 20

Explain expenditure switching policies

Answer 20

attempt to switch consumption away from imported goods and towards domestically produced goods

Does this through:
- Depreciation of the currency – makes imports less attractive

• Trade protection

Question 21

Explain supply side policies

Answer 21

• increase competitiveness
• lower costs of production for firms
• make firms more competitive in global market
• long run - lower rates of inflation - increase exports - addressing the current account deficit
• a disadvantage is that they take a long time to make effects felt

Question 22

What does the Marshall-learner condition state

Answer 22

if sum of PEDs for imports and exports is >1 then a depreciation will improve the trade balance — e.x if PED for imports greater than one - value for imports falls - positive effect on trade balance

If sum of PED is <1, depreciation will worsen trade balance

Question 23

Consequences of persistent current account surplus

Answer 23

low domestic consumption

insufficient domestic investment

appreciation of the domestic currency

inflation

reduced export competitiveness