Balance of Payments

Question 1

components of BOP

Answer 1

current
capital
financial accounts
net errors and omissions, which is the figure included to ensure the BOP balances

Question 2

components of current account

Answer 2

-trade balance (X-M)
-primary income - factor income and
-employee’s compensation
-secondary income - transfer payments b/w international orgs; aid; remittances

Question 3

components of financial account

Answer 3

1. FDI - inward and outward
2. portfolio investments in bonds and shares that do not involve legal control of firm
3. reserves of gold and FOREX (to settle debt and control ER)
4. bank deposits and loans

Question 4

difference between credit and debit terms

Answer 4

credit = outflows
debit = inflows

Question 5

evaluate the impact of a financial account deficit

Answer 5

1. may only be SR due to hot money flows, and in the LR will increase profits, interests and dividends on the CA (FDI)
2. depends on the cause - if due to LT lack of confidence in economic prospects, may result in capital flight, which reduces tax revenue, employment and growth

Question 6

define capital flight

Answer 6

rapid movement of large sums of money out of a country as residents move money from domestic to foreign banks and firms move some production abroad, due to a lack of confidence in a country’s economy or currency or political turmoil.

Question 7

evaluate the impact of a financial account surplus

Answer 7

in the SR, will finance a deficit on the CA and increase employment and growth, e.g. new FDI projects

in the LR, will result in deficit on primary income account (profits, dividends, interest, wages) of CA unless offset by an increase in country’s outward FDI and portfolio investment

Question 8

define the capital account

Answer 8

the balance of non-produced, non-financial assets like govt debt forgiveness, changes in migrant assets, sales and purchases of intellectual property rights

Question 9

why is the balancing item needed?

Answer 9

in theory, deficit on the CA should be balanced by equal surplus on capital and financial accounts as every credit item is matched by a debit item

in reality, it is hard to track such a huge number of transactions so errors occur that do not make the BOP balance.

e.g. if CA + CAP + FA = -2000m, a value of 2000m must have been missed out, so that would be the value of the balancing item

however, the value of the balancing items tends to fall over time as the quality of info improves

Question 10

define expenditure-switching policy

Answer 10

policy tools designed to encourage people to switch from buying imports to buying domestically produced products to improve the CA

Question 11

define expenditure reducing policy

Answer 11

tools designed to reduce imports and increase exports by reducing the overall level of AD and expenditure in the economy, which reduces imports and gives domestic producers an incentive to increase exports to make up for lost domestic dmand

Question 12

what are some policies used to correct CA imbalance?

Answer 12

con. fiscal
con monetary
SSP
ER devaluation
protectionism

***SSP and protectionism only used to correct deficit, not surplus

Question 13

what are some policies used to cause a financial account surplus?

Answer 13

SSP policies to increase competitiveness and productivity; increase macro stability; reduce red-tape and COP

both interventionist and MB SSP

Question 14

why would the govt want a FA surplus?

Answer 14

to promote econ development through inward FDI and employment income growth

selling shares in domestic firms will provide funds for investment and expansion

to finance a CA deficit

Question 15

how does a FA surplus finance a CA deficit?

Question 16

where is international borrowing recorded on the BOP and is it a credit or debit?

Question 17

examples of ES policies

Answer 17

ER policy - competitive devaluation/depreciation

protectionism - tarrifs, quotas, subsidies

SSP - any IN or MB policy to increase productive efficiency and international competitiveness

Question 18

examples of ER policy

Answer 18

contractionary fiscal
contractionary monetary

BE SPECIFIC - e.g. is it taxes or spending? IR?

Question 19

evaluate the use of ex red policy

Answer 19

• general arguments against FP and MP
• conflict of macro objectives of growth and unemployment and inequality/redistribution
• depends on the MPM abroad - may be low so will not be able to increase domestic X

Question 20

evaluate the use of protectionism as ES policy

Answer 20

• retaliation may worsen deficit
• inflationary if imports have low PED like oil/food
• depends on PES of X - can producers sell more?
• regressive impact on consumers (CS)
• may break WTO rules on free trade - penalties

Question 21

evaluate the use of ER policy as ES policy

Answer 21

• Marshall Lerner and J-Curve effect
• causes DP and CP inflation in LR that offsets competitiveness gain
• retaliation offsets

Question 22

evaluate the use of SSP as ES

Answer 22

any generic arguement e.g. time, cost, no guarantee, needs to be targeted, unintended consequences like structural unemployment

Question 23

evaluate whether ES or EXRED policy should be used

Answer 23

1. regardless of choice need to consider the trade-off so maybe SSP or policy combo would be best
2. depends on cause of CA deficit - cyclical or structural?
3. SR/LR effects - for immediate effect, ER, but for LR need SSP
4. is deficit large enough percentage of GDP to be a problem? Also may not be harmful because…
5. weigh up costs of policy with govt finances for SSP

Question 24

why might a CA deficit not harmful?

Answer 24

• if ER is floating like the pound, will self-correct
• depends on how it is being financed - sustainably with inward FDI or unsustainably with debt?
• depends on country - e.g. people may have more confidence in the US compared to a developing country, so can be sure of attracting a FA surplus through investments and less risk of capital flight