Balance Of Payments

Question 1

Define BOP (balance of payments)

Answer 1

It is all the financial transactions made between consumers, businesses and the government in one country with other nations

Question 2

What are the 3 accounts

Answer 2

Current
Capital
Financial

Question 3

What does the current account include

Answer 3

Takes up majority of the balance

The balance of trade in goods and services

Net primary income (interest, profits, dividends)

Net Secondary income (Contribution to EU, military aid)

Question 4

What does the capital account include

Answer 4

Transfers of the ownership of fixed assets.

Debt forgiveness

Sales/transfer of patents, copyrights, franchises, leases

Question 5

What does the financial account include

Answer 5

Takes up more of the balance than the capital account

Portfolio investment
Assets such as shares, bonds

FDI

Question 6

How is a cyclical BOP deficit or surplus caused

Answer 6

A cyclical BOP deficit or surplus is caused by the state of the economy such as if in a boom, tax receipts are high and spending on unemployment is low.

Question 7

How is a structural BOP surplus or deficit caused by

Answer 7

A structural BOP deficit or surplus is cause by structural factors such as supply side causes(education)

Question 8

What are the causes of a structural current account surplus

Answer 8

Long run technological advancement

Long run rise in global prices of main exports

Structural increase in net investment income

Trend rise in factor productivity

Question 9

What are the causes of a cyclical current account surplus

Answer 9

Depreciation of the exchange rate

Strong consumer demand in export markets

Cyclical improvements in terms of trade

Fall in costs of essential imports

Question 10

Define terms of trade

Answer 10

The terms of trade measures the volume of imports an economy can receive per unit of exports

Question 11

What is the formula for terms of trade

Answer 11

Formula:
Average export prices (index) / Average import prices (index) x 100

Question 12

How does the terms of trade improve

Answer 12

If export prices increase compared to import prices, the term of trade improves.

Question 13

What are the benefits of a current account surplus

Answer 13

Contributor to GDP

Increased employment

Economic stability

Question 14

What are the causes of a structural current account deficit

Answer 14

Under investment

Low productivity

Constant high inflation

Low innovation

Question 15

What are the causes of a cyclical current account deficit

Answer 15

Overvalued exchange rate

Recession in key export markets

Fall in global prices of exports

Increased demand for imported technology

Question 16

How is depreciation a policy to reduce a BOP deficit

Answer 16

Depreciation involves reducing the value of the currency against others and making exports cheaper (^competitive) and imports more expensive.

However, it will depend on the elasticity of demand for exports and imports, demand needs to be elastic for devaluation to be useful.

Question 17

How is reducing consumer spending a policy to reduce a BOP deficit

Answer 17

Reduce consumer spending, the government could pursue tight fiscal policy (higher taxes to reduce consumer spending) or increase interest rates to reduce spending, this will cause less spent on imports therefore improving the current account.

However, this policy will conflict with other macroeconomic objectives.

Question 18

How does supply side policies reduce a BOP deficit

Answer 18

Supply side policies, these are policies aimed at increasing productivity and competitiveness, if successful this will make UK exports more competitive and export demands will rise.

This will take a while to come into effect but this will help other areas of the economy such as economic growth.

Question 19

How does protectionist measures reduce a BOP deficit

Answer 19

Protectionism, putting tariffs on imports could lead to a fall in import spending and improve the current account

But this will likely lead to retaliation and a fall in exports.

Question 20

What are drawbacks to a large current account surplus

Answer 20

It represents an unbalanced economy — dominated by exports and showing low levels of consumer spending.

If one country runs a large current account surplus, it means other countries will have a similar deficit.

In the Eurozone, current account imbalances are more of a problem because countries can’t rely on a depreciation to solve the imbalance.

Question 21

How could the government reduce a current account surplus

Answer 21

Allowing the exchange rate to appreciate, reducing competitiveness.

• Encouraging consumer spending (e.g. lower income tax), leading to higher import spending.

Question 22

What is the effect of having a current account deficit

Answer 22

Lower AD.
A deficit (X-M) represents a leakage from the economy. Money is being spent in other countries and, therefore, ceteris paribus, it reduces UK aggregate demand. On the other hand, a current account deficit may occur due to high levels of consumer spending and economic growth.

Depreciation.
A current account deficit could cause a depreciation in the value of the exchange rate, because we are buying imports and, therefore, buying foreign currency. A depreciation will improve the current account, because it makes exports more competitive.

Question 23

What are the general causes of a current account deficit

Answer 23

Appreciation
High economic growth (more spending on imports)
Membership of Trade union (EU)

Question 24

What are the general causes of a current account surplus

Answer 24

More competitive (depreciation)
High interest rates

Question 25

Define balancing item

Answer 25

The components of the Balance of Payments should balance. That is, the sum of the accounts should be zero

Question 26

Define Cyclical BOP

Answer 26

Cyclical Balance of Payments refers to the fluctuations in a country’s BoP that are influenced by the business cycle.

Question 27

Define Structural BOP

Answer 27

Structural Balance of Payments refers to persistent imbalances that arise from fundamental and long-term issues within an economy.