Balance of Payments

Question 1

Current Account Balance

Answer 1

o Trade balance + net foreign income balance
o Net foreign income includes capital income (interest, dividends), labour income (wages/salaries) and tax and transfers (foreign aid, remittances)

Question 2

Financing a Current Account Deficit

Answer 2

o Achieved by borrowing or selling assets to foreigners

Question 3

Capital Account

Answer 3

o Includes foreign direct investment, government transactions and portfolio investment (purchases of government securities, purchases of corporate equity, bank and non-bank loans)

Question 4

External Position

Answer 4

• Net foreign liabilities = gross foreign liabilities – gross foreign assets

Question 5

Perspectives on Current Account Deficit

Answer 5

• Pessimistic view – current account deficit arises because we have low savings → debt burden will grow or lower holdings of assets due to foreign sales → consumption will fall in the future
• Optimistic view – capital account surplus arises because our economy is a good place to invest and we receive a large flow of savings from low-growth countries

Question 6

Demand for Assets

Answer 6

Real return on domestic assets
o High real return → domestic assets are more attractive for foreign investors and foreign assets are less attractive for domestic investors
Real returns on foreign assets
o High real return → foreign assets are more attractive for domestic investors and domestic assets are less attractive for foreign investors
Risk premia
o Increase in domestic risk → decrease willingness of foreign investors to invest here
o Increase in foreign risk → decrease willingness of domestic investors to invest overseas