Balance of Payments

Question 1

What is the balance of payments?

Answer 1

The balance of payments is a record of the value of all transactions between the residents of one country and the residents of all other countries in the world over a given period of time. The three main components of the balance of payments are the current account, the capital account and the financial account.

It always balances to zero

Question 2

What do we call money flowing into and out of the country?

Answer 2

Into- Credit

Out-to- Debit

Question 3

What is the current account?

Answer 3

A record of all the money coming into and going out of a country for trade in goods and services, income transfers and current transfers.

Question 4

What are the components of current account?

Answer 4

Balance of trade in goods

Balance of trade in services

Income transfers- Factor payments for factors of production

Current transfers- Stuff that isn’t necessarily for anything in return(e.g. remittances)

Question 5

What is capital account?

Answer 5

record of all the transfers of ownership of capital and other assets between countries.

Question 6

Components of capital account?

Answer 6

Capital transfers- transfers of fixed assets+debt forgiveness

Transaction in non-produced, non-financial assets- e.g. rights, patents

Question 7

What is financial account?

Answer 7

record of all financial transactions and direct investment between countries, and currency reserves held by central banks.

Question 8

Components of financial account?

Answer 8

Direct investment: When a firm or part of a firm is bought

Portfolio investment: Purchase and sale of financial capital- shares, bonds, derivatives, the trading of commodities and currencies

Reserve assets: foreign currency reserves held by central banks

Question 9

Why does the balance of payments balance?

Answer 9

Because currencies can only be spent within the country

Question 10

Current account deficit. What could this mean? Could it balance out over time?

Answer 10

If foreign countries have an increasing supply of currency form exporting, they could
A. Buy imports, moving the exchange rate back
B. save- deficit persists

Question 11

What is current account deficit?

Answer 11

the sum of the balance of trade and current and income transfers is negative

Question 12

Consequences of a current account deficit

Answer 12

Foreign ownership of domestic assets

Exchange rates- If deficit is large, the exchange rate can be pushed up. Country needs to borrow to pay back, so interest rates spike…

Indebtedness

Question 13

What is International credit ratings

Answer 13

A measure of a country’s deficit. AAA is best, and it goes to D

Question 14

Is current account deficit always bad?

Answer 14

No. It could be that it is caused by hella lot of imports, that could signify a growing economy

Question 15

Correcting CA deficit with expenditure reducing policies

Answer 15

Gov uses contractionary fiscal policy to reduce quantity imported.(less income to spend)

Question 16

Correcting CA deficit with supply side policies

Answer 16

Increasing the competitiveness of exports. Maybe there is a reason why the CA is so shit

Question 17

What is the Marshall-Lerner condition?

Answer 17

a currency depreciation will improve the balance of trade if the sum of PEDX and PEDM is greater than 1. It is important to note that it may take some time, as the J curve means that elasticities may increase

Question 18

Can a current account surplus be a bad thing?

Answer 18

Yes. The issue is that the BOT has to balance, and as a result a surplus here could mean a financial account deficit.

Other countries buy local currency, so your country has more foreign currency. The country could then do one of 2 things:

A. Spend to buy imports. This would return CA to normal

B. Spend in other countries. This may mean that the supply of foreign currency increases AGAIN. This is bad, as financial deficit would increase

Question 19

Things to consider about a surplus in CA

Answer 19

Lower domestic consumption and investment. This is because of the upward pressure on currency

Appreciation of currency- May or may not be bad- ML condition

Reduced export competitiveness

Employment- Would it increase? Decrease? This depends if the origin of the surplus is because of reduced imports or increased exports