Balance Of Payments

Question 1

What is the BALANCE OF PAYMENTS

Answer 1

It measures a country’s transactions with the rest of e world and is comprised of two main elements.
The current account and Capital/financial account

Question 2

What does the CURRENT ACCOUNT do (4)

Answer 2

1. Net trade in goods - cars, clothes
2. Net trade in services- tourism, banking
3. Net investment incomes- profits sent back to country of origin
4. Net transfer flows- payments to the EU

Question 3

What is a current account deficit?

Answer 3

The value of imports is greater that the value of exports

Question 4

A deterioration of the current account means the deficit gets what?

Answer 4

Bigger

Question 5

Capital/ Financial account measures what? (2)

Answer 5

1. Short term capital flows- investors saving money in UK banks
2. Long term capital flows- Japanese firms investing in the UK

Question 6

What is the Capital/Financial account?

Answer 6

Refers to transfer of funds associated with buying fixed assets, such as land

Question 7

What is the balance of payments equilibrium?

Answer 7

If there is a deficit in the current account there will be a surpluses equal to that in the capital account. Vice Versa

Question 8

Reasons for a current account deficit (5)

Answer 8

1. Overvalued exchange rate
2. Declining Competitiveness
3. Fast economic growth
4. Low savings ratio
5. Capital inflows

Question 9

How does overvalued exchange rate cause CAD

Answer 9

Makes exports more expensive so imports are cheaper.

Question 10

How do declining competitiveness cause CAD

Answer 10

If Prices increase in the UK more than Europe then demand decreases for UK exports

Question 11

How does fast economic growth cause CAD

Answer 11

As we already import more an increase in spending leads to more imports

Question 12

How does a lower saving ratio cause CAD

Answer 12

Lower savings tend to cause an increase in consumer spending on imports

Question 13

How does capital inflows lead to CAD

Answer 13

Large inflows of foreign capital leads to increase in imports

Question 14

Problems with Current Account Deficit (4)

Answer 14

1. Potentially unsustainable
2. Foreign claim on UK assets
3. Depreciation
4. Reflection of economic weakness
5. lower ad

Question 15

Why is the CAD potentially unsustainable

Answer 15

If he CAD is financed through borrowing long term, countries are burdened with high interest payment

Question 16

How does the CAD mean more foreign claim on UK assets

Answer 16

If the deficit is financed by long term investment foreigners will have an increasing claim

Question 17

How does the CAD lead to depreciation

Answer 17

It’s likely to cause depreciation and an increase on import prices and decrease the standard of living

Question 18

How does the CAD reflect economic weakness

Answer 18

Could be argued that a persistent deficit suggests fundamental weakness

Question 19

Why is the CAD not always harmful (4)

Answer 19

1. Finance investment
2. Inward investment can benefit the economy
3. Floating exchange rate will restore balance
4. Size of deficit

Question 20

Measures to reduce the current account deficit (4)

Answer 20

1. Devaluation/depreciation - P i+= QD - weaker pound so E attractive- i expensive
2. Deflationary policies- +i people save more less spending also +import tax
3. Supply side policies- improve competition by improve labour productivity, make exports more appealing
4. Protectionism- + tariffs= i- in short term

Question 21

How does a CAD lead to lower ad?

Answer 21

If imports are greater than exports then (X-M) is going to be negative. This means ad will drop