balance of payments

Question 1

balance of payments

Answer 1

the balance of payments is 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.

Question 2

exports

Answer 2

are goods/services sold to foreign countries and are positive in the balance of payments. this is because they are an inflow of money

Question 3

imports

Answer 3

are goods/services brought from foreign countries and they are negative on the balance of payments.
they are an outflow of money

Question 4

the current account

Answer 4

• this includes all economic transactions between countries. the main transactions are the trade in goods/services, income and current transfers.
• income transfers are from the net earnings on foreign investment as well as net cash transfers. they include salaries and dividends
• current transfers are transfers that have no return, such as aids and grants. it includes the payments the uk makes for being a member of the EU.
• they have traditionally been negative for the uk, due to contributions and because of overseas aid

Question 5

the balance of aid is made up of

Answer 5

• the current account
• the capital account and financial account
• balancing item

Question 6

the capital account and financial account

Answer 6

capital transfers involve transfers of the ownership of fixed assets.
the financial account involves investment .
e.g. direct investment, portfolio investment and reserve assets are part of the financial account

Question 7

balancing account

Answer 7

the components of the balance of payments should balance. that is, the sum of the account should be zero. where there are imbalances, a balancing item is used to cover discrepancies.

Question 8

important macroeconomic policy objective:

a sustainable balance of payments position

Answer 8

• aim for the current account to be satisfactory, so there is no large deficit. usually near equilibrium
• a BOP equilibrium on the current account means the country can sustainably finance the current account- important for long term growth
• difficult to attract sufficient capital flows- then the £ could depreciate- lead to inflationary pressures on uk price level
• an imbalance suggests that the uk is reliant on the performance of other countries
• become more difficult to finance the deficit in the long run

Question 9

balance of payments imbalances

Answer 9

the components of the BOP should balance to give a net value of 0.
however, each component can have an imbalance, which means there is either a deficit or surplus on the component.
for example, uk has a net deficit on the current account, whilst there is a net surplus on the capital and financial accounts

Question 10

causes of balance of payments imbalances: current account deficits and surpluses

Answer 10

• current account deficits and surpluses
• appreciation of the currency
• economic growth
• more competitive
• deindustrialisation
• membership of trade union
• capital account deficits and surpluses
• attractiveness to foreign investors

Question 11

current account deficits and surpluses

Answer 11

-a current account surplus means there is a net inflow of money into the circular flow of income. uk has a surplus with services and a deficit with goods
-uk has a net current account deficit, meaning 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.

Question 12

appreciation of the currency

current account deficits and surpluses

Answer 12

a stronger currency means imports are cheaper and exports are more expensive, which means the current account deficit would worsen

Question 13

economic growth
(current account deficits and surpluses)

Answer 13

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

Question 14

more competitive
(current account deficits and surpluses)

Answer 14

if a country becomes more internationally competitive, such as with lower inflation or if there is economic growth in export markets, exports should increase.
this could cause the current account deficit to improve, or increase the current account surplus

Question 15

deindustrialisation

current account deficits and surpluses

Answer 15

the manufacturing sector has been declining since the 1970s. the goods the uk previously made domestically now have to be imported, which worsens the deficit

Question 16

membership of trade union

current account deficits and surpluses

Answer 16

the uk has traditionally had negative current transfers, since fees are paid for membership of the EU

Question 17

capital account deficits and surpluses

Answer 17

where there is a current account surplus, there is a capital and financial account deficit. a current account deficit means there will be a capital and financial surplus

Question 18

consequences of imbalances on the BOP

Answer 18

• if imported raw materials are expensive, there could be cost-push inflation in the domestic economy, since firms face higher production costs
• international trade - countries become interdependent. therefore, the economic conditions in one country affect another country, since the quantity the export/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

Question 19

policies to correct imbalances on the BOP

fiscal policy

Answer 19

• a deficit on the current account- income tax could increase. this will reduce the amount of disposable income consumers have, which will reduce the quantity of imports. however, it might also impact domestic growth, since consumers will also spend less on domestic goods
• government reduce their spending- could reduce AD and lead to less imports. forcing domestic firms into increasing exports, which helps improve the disequilibrium
• FP 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.
• government may have imperfect information about economy- lead to government failure
• if taxes are imposed on trading partners, there is a risk of retaliation, which could reduce demand for exports, too

Question 20

policies to correct imbalances on the BOP

monetary policy

Answer 20

• expenditure reducing policies: aim to reduce demand in the economy, so spending on imports falls.
• expenditure switching policies: aim to switch consumer spending towards domestic goods, and away from imports

> reducing the growth of the supply of money in an economy- expenditure reducing or expenditure switching
if there is a current account deficit, banks might lower interest rates to cause depreciation in the currency - causes exports to become cheaper,but could also be inflationary for the domestic economy. hot money might flow out of 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
it is hard to control the supply of money in reality. moreover, there is a significant time lag with changing the interest rate and seeing an effect.

Question 21

policies to correct imbalances on the BOP

supply- side policy

Answer 21

• could help increase productivity with increased spending on education and training, could result in country becoming more internationally competitive - lead to a rise in exports. however this incurs a significant time lag, so it is not effective as an immediate measure. useful in the long term.
• help make the domestic economy attractive to investors
• domestic economy could be made more competitive through deregulation and privatisation, which will force firms to lower their average costs. however, privatisation could result in monopolies being formed- will not increase efficiency
• if government provides subsidies to some industries to encourage production, there could be retaliation from foreign countries that see this as an unfair protectionist policy