Balance of Payments

Question 1

The Current Account

Answer 1

The Trade Balance:
The value of exports minus the value of imports. X-M.

The Income Balance (Primary Income):
Income flows into the country minus the income flows out of the country.

Current Transfers (Secondary Income):
Workers remittances, donations, tax payments, foreign aid and grants.

Question 2

The Capital and Financial Account

Answer 2

This comprises transactions associated with changes of ownership of the UK’s foreign financial assets and liabilities.

It includes FDI, share and bond investments, changes in foreign exchange reserves and hot money flows.

Question 3

Causes of Current Account Deficits

Answer 3

-Low productivity relative to other countries
-High inflation relative to other countries
-An overvalued exchange rate
-Dependency on imported raw materials
-Manufacturing moving to developing countries
-Protectionism by other countries
-Poor quality goods

Question 4

Causes of Current Account Surpluses

Answer 4

-High productivity relative to other countries
-Relatively low inflation
-Undervalued exchange rate
-Abundance of raw materials
-Protectionist policies

Question 5

Measures to Reduce a Current Account Imbalance

Answer 5

Supply-side Policies:
-Market based methods such as privatisation
-Interventionist methods such as education

Expenditure-Reducing Policies:
-Contractionary Fiscal Policy to tackle inflation
-Contractionary monetary policy such as raised interest rates.

Expenditure-Switching Policies:
-Protectionist policies to limit imports
-Devaluation of a currency to make exports competitive

Question 6

Significance of Trade Imbalances

Answer 6

In the long run, current account deficits should lead to a weaker currency, which would then bring the balance back to the current account, dependent on a floating exchange rate.