Balance of Payments

Question 1

Balance of Payments

Answer 1

1. Current Account
2. Financial Account
3. Capital Account

Question 2

Current Account

Answer 2

Trade Balance (X-M) - Visible + Invisible trade

Income Balance -
Primary Income - Investment returns (eg. dividends)
Secondary Income - Aid, gifts, family payments

Question 3

Financial Account

Answer 3

Portfolio Investment
FDI - Investment which gives the investor a say in the company’s decision making (>10% share).

Question 4

Capital Account

Answer 4

Debt forgiveness
Inhertitance Tax
Death duties

Question 5

Recent UK Current Account

Answer 5

Large deficit in visible trade (goods)
Surplus in invisible trade (services)
Surplus in primary income
Deficit in secondary income (aid)

Large overall CA deficit since 1984

Question 6

Structural causes of a CA Surplus

Answer 6

Savings > Investment
Long-run competitive advantage
Rise in global prices
Increased net investment income
Rising factor productivity

Question 7

Cyclical causes of a CA Surplus

Answer 7

Falling ER
High demand for British exports
Improved terms of trade
Fall in factor input prices
Rise in net inflows / profits

Question 8

Consequence of CA Surplus

Answer 8

Increasing GDP
Potential Demand-pull inflation (Capacity ?)
Accumulation of foreign exchange reserves
ER apreciation
Net exporter of capital
Could trigger protectionism

Question 9

Cyclical causes of a CA deficit

Answer 9

High consumer spending
High YED for imports
UK exports are uncompetitive
SPICED
Foreign recessions
Falling interest rates

Question 10

Structural causes of a CA deficit

Answer 10

Low investment levels
Factor immobility
Falling productivity
Low Quality
Increased production costs
Increased raw material costs
Low relative quality

Question 11

Expenditure-Switching Policy to reduce CA deficit

Answer 11

Supply-side policy → Resolves structural problems in the economy, reducing the price of domestic goods, promoting the consumption of domestic goods rather than imported goods.
Protectionist Policy → Eg. Tariffs / Quotas - In order to restrict the supply of imported goods and promote the consumption of domestic products.

Question 12

Exchange rate manipulation to reduce CA deficit

Answer 12

Devalue the exchange rate (WPIDEC) → This would lead to domestic exports becoming more internationally competitive, aiding the trade balance (X>M).

The Marshall Lerner Condition must be met.

Question 13

Expenditure-Restricting Policy to reduce CA deficit

Answer 13

Fiscal Policy → Reducing levels of consumption via greater levels of tax / reduction of subsidies.

Question 14

Surplus reduction policy

Answer 14

Appreciate the exchange rate (SPICED) → Domestic exports become less internationally competitive, resulting in a reduction in demand.
Likely fall in output / potential unemployment

Question 15

Impact of rebalancing BoP (Global)

Answer 15

Successful supply side policy can lead to a greater volume of trade
Trade wars may occur following the imposition of tariffs/quotas, dynamic loses
Breaking of WTO rules
Potential harm to developing economies

Question 16

Impact of rebalancing BoP (Domestic)

Answer 16

Worsen CA defict if Marshall Lerner is not met
If exports are less demanded (Surplus)- unemployment
Inflation if PED is inelastic