6.3 The Balance Of Payments Flashcards

1
Q

Define balance of payments

A
  • a record of all financial transactions made between consumers, firms and the government from one country with other countries.
  • It states how much is spent on imports, and what the value of exports is.
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2
Q

Define exports

A
  • goods and services sold to foreign countries
  • positive in the balance of payments.
  • they are an inflow of money.
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3
Q

Define imports

A
  • goods and services bought from foreign countries
  • negative on the balance of payments
  • they are an outflow of money.
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4
Q

What is the balance of payments made up of?

A
  • The current account
  • The capital account
  • The financial account
  • Balancing item
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5
Q

Define current account

A
  • includes all economic transactions between countries.
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6
Q

What are the 4 sections of the current account?

TTPS

A
  • trade in goods
  • trade in services
  • primary income
  • secondary income
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7
Q

What is meant by the trade balance?

A
  • trade in goods + trade in services
  • exports - imports
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8
Q

What is meant by the income balance?

A
  • primary income + secondary income
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9
Q

Give two examples of primary income

A
  • income from interest
  • income from shares and profits
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10
Q

Give two examples of secondary income?

A
  • EU payment
  • Repatriation of wages
  • Aid and grants
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11
Q

Define capital account

A
  • involve transfers of the ownership of fixed assets.
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12
Q

What are the three sections of the capital account?

DID

A
  • debt forgiveness
  • inheritance tax
  • death duties
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13
Q

Define financial account and give its two sections

A
  • The financial account involves investment.
  • For example, direct investment, portfolio investment and reserve assets are part of the financial account.
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14
Q

Give three examples of portfolio investment

CGH

A
  • corporate shares and bonds
  • government bonds
  • hot money
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15
Q

Define balancing item/ What is the sum of the current account, the financial account, and the capital account?

A
  • The components of the Balance of Payments should balance.
  • the sum of the accounts is 0
  • Where there are imbalances, a balancing item is used to cover the discrepancies.
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16
Q

What is the Marshall Lerner condition?

A
  • states that a depreciation/devaluation of a currency will eventually lead to a net improvement in the trade balance on the BoP if the PEDx + PEDm > 1
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17
Q

What is a current account surplus?

A
  • means there is a net inflow of money into the circular flow of income.
  • The UK has a surplus with services, but a deficit with goods.
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18
Q

What are the two types of causes of current account surpluses?

A
  • structural
  • cyclical
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19
Q

List 3 causes of a structural current account surplus

A
  • significant long-run comparative advantage
  • trend rise in factor productivity
  • long-run rise in global prices of main exports
  • surplus of savings over investment
  • structural increase in net investment income
20
Q

List 3 causes of a cyclical current account surplus

A
  • depreciation of the exchange rate
  • strong consumer demand in key export markets
  • fall in prices of imported energy / FoP
21
Q

What is a current account deficit?

A
  • UK has a net current account deficit.
  • This means the UK spends more on imports from foreign countries, than they earn from exports to foreign countries.
  • If the deficit is large and runs for a long time, there could be financial difficulties with financing the deficit
22
Q

What is meant by a cyclical trade deficit?

A
  • one that occurs as a result of the trade cycle being in the growth/boom phase
23
Q

What is meant by a structural trade deficit?

A
  • long term in nature
  • occurs due to an underlying lack of productivity and international competitiveness in the economy
24
Q

What are the causes of balance of payments disequilibrium?

Appreciate Everything My Dear Miss Angel

A
  • Appreciation of the currency:
    -a stronger currency means imports are cheaper and exports are relatively more expensive (SPICED) which means the current account deficit would worsen.
  • Economic growth:
    -when consumer incomes increase, demand increases.
    -this could increase demand for imports.
    -this is especially true of a country such as the UK, where consumers have a high propensity to import.
  • More competitive:
    -if a country becomes more internationally competitive, such as with lower inflation or if there is economic growth in export markets, exports should increase.
    -also occurs when a country becomes more productive, since that causes average unit costs to fall.
    -could cause the current account deficit to improve, or increase the current account surplus.
  • Deindustrialisation:
    -In the UK, the manufacturing sector has been declining since the 1970s.
    -The goods that the UK previously made domestically now have to be imported, which worsens the deficit.
  • Membership of trade union:
    -The UK has traditionally had negative current transfers, since fees are paid for membership of the EU.
  • Attractiveness to foreign investors:
    -A capital account surplus could be caused by incoming finance from investors buying UK bonds, securities and financial derivatives.
    -This could help fund a current account deficit.
25
Q

What occurs when there is a current account surplus?

A
  • there is a capital and financial account deficit.
26
Q

What occurs when there is a current account deficit?

A
  • there will be a capital and financial account surplus.
27
Q

What happens if the UK sells more exports to foreign countries?

A
  • the UK will have a greater inflow of money into the circular flow of income.
  • This will increase AD and improve the rate of economic growth.
28
Q

What happens to the UKs current account deficit during recessions?

A
  • the current account deficit falls.
  • this is because consumer spending falls.
29
Q

What is the impact of higher incomes on the currency account during periods of economic growth?

A
  • During periods of economic growth, when consumers have higher incomes and they can afford to consume more
  • there is a larger deficit on the current account.
30
Q

What is the impact of raw materials?

A
  • If imported raw materials are expensive, there could be cost-push inflation in the UK, since firms face higher production costs.
31
Q

What happens to imports and exports when the pound appreciates?

Acronym-SPICED

A
  • imports become relatively cheaper and exports become more expensive
32
Q

What happens to the UK economy if it becomes more productive?

A
  • the UK will be more internationally competitive.
  • this causes exports to increase relative to imports.
33
Q

What is Foreign Direct Investment?

A
  • the flow of capital from one country to another, in order to gain a lasting interest in an enterprise in the foreign country.
34
Q

What are the consequences of investment flows between countries?

A
  • FDI can help:
    -create employment opportunities
    -encourage innovation of technology
    -help promote long term sustainable growth.
  • Provides LEDCs with funds to invest and develop.
  • Portfolio investments are passive, control over the company is not gained.
    -The investment aims to make a financial gain.
  • FDI, on the other hand, allows the investor to gain some control over the firm.
    -It includes finance such as pension funds, hedge funds and stock
    market money flows.
35
Q

What are the policies that might be used to correct a balance of payments deficit or surplus?

A
  • Fiscal policy
  • Monetary policy
  • Supply-side policies
36
Q

How might fiscal policies be used to correct a balance of payments deficit?

A
  • If there is a deficit on the current account, income tax could be increased.
    -This will reduce the amount of disposable income consumers have, which will reduce the quantity of imports.
    -EVAL: However, it might also impact domestic growth, since consumers will also spend less on domestic goods.
  • Governments could also reduce their spending.
    -This would reduce AD and lead to less imports.
    -It forces domestic firms into increasing exports, which helps improve the disequilibrium.
37
Q

How effective are fiscal policies being used to correct a balance of payments deficit or surplus?

EVALUATION POINTS

A
  • Fiscal policy is effective in the short term
  • But not so much in the long term.
    -As soon as the policy measures end, household are likely to revert their expenditure back on imports.
  • If taxes are imposed on trading partners, there is the risk of retaliation, which could reduce demand for exports, too.
  • Governments might have imperfect information about the economy, so it could lead to government failure.
  • If ‘green taxes’ are implemented, such as carbon taxes, or if there are minimum prices on pollution permits, the competitiveness of domestic firms could be compromised.
    -This could reduce exports from domestic firms.
38
Q

Monetary policy:
What is meant by expenditure-reducing policies?

A
  • policies designed to control demand and limit spending on imports
39
Q

Monetary policy-What is the aim of expenditure reducing policies?

A
  • to reduce demand in the economy, so spending on imports fall.
40
Q

Monetary Policy:
What is meant by expenditure-switching policies?

A
  • policies designed to change the relative prices of exports and imports - this causes changes in spending away from imports and towards domestic/export production
41
Q

Monetary policy-What is the aim of expenditure switching policies?

A
  • to switch consumer spending towards domestic goods, and away from imports.
42
Q

How might the monetary policy be used to correct a balance of payments deficit or surplus?

A
  • If there is a current account deficit, the bank might lower interest rates to cause depreciation in the currency.
    -this causes exports to become cheaper, and imports to become more expensive
    -but it could be inflationary for the domestic economy.
  • Moreover, hot money might flow out of the country, since investors are not
    receiving a high return on their investment.
  • High interest rates could be expenditure-reducing, since the demand for imports falls and inflation might fall.
  • Changing the exchange rate could be a government expenditure-switching policy.
43
Q

How effective is the monetary policy being used to correct a balance of payments deficit or surplus?

EVALUATION POINTS

A
  • it is hard to control the supply of money in reality.
  • there is a significant time lag with changing the interest rate and seeing an effect.
44
Q

How might supply-side policies be used to correct a balance of payments deficit or surplus?

A
  • Supply-side policies could help increase productivity with increased spending on education and training, -could result in the country becoming more internationally competitive.
    -this could lead to a rise in exports.
    -(can be an effective policy in the long term)
  • Supply-side policies could also help make the domestic economy attractive to investors.
  • The domestic economy could be made more competitive through deregulation and privatisation, which will force firms to lower their average costs.
45
Q

How effective are supply-side policies being used to correct a balance of payments deficit or surplus?

EVALUATION POINTS

A
  • Increased spending on education and training incurs significant time lag, so it is not effective as an immediate measure.
  • Privatisation could result in monopolies being formed, which will not increase efficiency.
  • If governments provide subsidies to some industries to encourage production, there could be retaliation from foreign countries that see this as an unfair protectionist policy.
46
Q

What is the significance of deficits and surpluses for an individual economy?

EVAL/ANALYSIS

A
  • If imported raw materials are expensive, there could be cost-push inflation in the domestic economy, since firms face higher production costs.
  • International trade has meant countries have become interdependent.
    -Therefore, the economic conditions in one country affect another country, since the quantity they export or import will change.
  • A surplus or deficit on the current account could indicate an unbalanced economy, and it could mean the country is too reliant on other economies for their own growth.
  • It could be difficult to attract sufficient financial flows in order to finance a current account deficit.
    -This could make it unsustainable in the long run.
47
Q

What are the implications for the global economy of a major economy/economies with imbalances deciding to take corrective action?

APPLICATION

A
  • An imbalance suggests that the UK is reliant on the performance of other countries.
    -If export markets, such as the EU, become weak, UK economic performance will be affected.
    -This was seen during the 2008 financial crisis.
  • It could become difficult to finance the deficit in the long run.
  • In the Eurozone, current account deficits are of greater concern because the countries have a fixed exchange rate.
    -This means they cannot devalue the currency to restore their level of international competitiveness.
  • Since 2006, the US deficit with China narrowed and China’s surplus also fell.
    -A surplus indicates low consumer spending and a low savings ratio, which puts China at the risk of having unsustainable economic growth.
    -(However, the government now aims to grow the economy using domestic spending, rather than exports)
  • China made their exports more competitive by undervaluing their currency.
    -This makes their imports more expensive
    -(however, so it could be inflationary and cause a boom or bust)
  • A stronger Yuan causes lower growth, lower inflation and reduces the current account surplus.
    -The US would prefer a stronger Yuan since it makes their domestic industries more competitive.