Balance of payments

Question 1

What is the balance of payments ?

Answer 1

A record of all currency flows in and out of a country over a time period

Question 2

What are the 3 sections of the balance of payments ?

Answer 2

Current account
Capital account
Financial account

Question 3

What is the current account ?

Answer 3

Show the difference between the amount received from imports and exports

Question 4

What are the 4 elements of the current account ?

Answer 4

Trade in goods - Difference of imports and exports ( deficit or surplus )
Trade in services - Difference of import and export services
Investment income - Money in and out from employment / earlier investment
Secondary income - Moving of money paying for G / S via investment / aid or donations overseas

Question 5

What does the financial account look at ?

Answer 5

Records capital flows in and out of a country via 5 areas

Question 6

What are the 5 areas areas the financial account looks at ?

Answer 6

Long term capital flows
Portfolio investment
Short term hot money
Reserve drawings
Financial derivatives

Question 7

What is long term direct capital flows ? ( financial account )

Answer 7

The acquisition of productive assets E.G factories / Oil refineries

These are outward flows which are slow and predictable

Flows are in response to decisions to invest in areas with comparative advantage

Question 8

What are portfolio investments ? ( financial account )

Answer 8

Purchasing of financial assets rather than physical productive assets , E.G purchasing a country’s bonds / shares and securities )

Managers from financial institutions purchase shares in overseas companies

Globalisation has reduced the barriers making it easier to buy overseas shares

Question 9

What is “ Hot money “ capital flows ?

Answer 9

Flowing of money across international boarders , moving to find the greatest short term gains

This is on a large scale , it also destabilises a country’s exchange rate yet safe currencies such as the dollar attracts this “ hot money “ as the ER will not budge

Question 10

How are deficits and surpluses affect the current account ?

Answer 10

If a country is in a deficit , it shows that the outflows are greater than their inflows

Those in a deficit may be forced to use import controls unless a surplus nation is willing to give up a % of its surplus

Mainly non oil exporting nations face deficits

Question 11

How impactful are deficits to a country ?( short and long term )

Answer 11

Short term = negligible / see improved living standards from cheaper higher quality goods

Long term = If caused by uncompetitive economy is bad as it will lead to the decline of national industries and lower living standards

Question 12

Do current account surpluses pose problems ?( short and long term )

Answer 12

They are signs of economic prosperity , better surplus = better performance . However in the long term this may cause inflation in that nation / Also it may attract FDI from foreign nations

Question 13

What are some factors affecting a GOVT’s balance of payments ?

Answer 13

Productivity - improving out put per worker is crucial for supply side policies / quality against competition in the global economy

Inflation - If it is greater than competitors inflation stats , that nations export competitiveness will fall leading to damaging current account balance

Exchange rates - A rise in ER means that nations will import less of your goods , thus imports become more cheaper for the nation with the higher ER , If they fall inline with inflation then they both cancel out

Question 14

What are some policies to reduce a balance of payments deficit ?

Answer 14

Deflation ( Fiscal policy to reduce AD )

Direct controls ( quotas , import controls , tariffs )

Devaluation of the ER

Question 15

How do supply side policies affect the current account ?

Answer 15

Long term improvements in supply side policies makes the goods a country produces more quality competitive in the global markets / price competitive

Low ER , Low inflation , Low I rates all increase price competitivness as it promotes greater investment in R/D

Question 16

What are the cons of consumption led growth ?

Answer 16

Increases imports into the country which increases the deficit , Forcing banks to deflate AD Potentially causing a recession

Unsustainable - rapid growth caused by increased borrowing leads to speculation ( destabilises the performance of the economy ) especially in the housing market

Question 17

What are some government policies to reduce a balance of payments surplus ?

Answer 17

Reflation - to raise demand via expansionary monetary policy / increases demand for imports

Removal of import controls - To liberalise trade / increase imports to increase inflation

Revaluation - Increasing the cost of the currency , reduces imports of a country and makes them less competitive which reduces the surplus for example japan and china

Question 18

What are the impacts of a deficit on individuals ?

Answer 18

Short run = Not as serious , they may see an increase in standard of living due to good quality imported goods

Long term = Reflects an uncompetitive economy / reduced industrial output . leading to higher unemployment and causes wages to decline which in turn reduces the standard of living if they become internationally uncompetitive

Question 19

What is the impact of a balance of payments surplus on individuals ?

Answer 19

Surpluses are seen as good as they show steady / good economic performance - in the short term they will see higher wages and better job security as exports grow

Large surplus may be bad though - May lead to inflation issues - more money circulating without the same level of output causing purchasing power to erode