Balance of Payments & Policies to reduce the Current Account Deficit

Question 1

Define Balance of Payments.

Answer 1

is a record of a country’s transactions with the rest of the world. It shows the receipts from trade.

Question 2

What does the Balance of Payments consist of?

Answer 2

It consists of the current and financial account

Question 3

Explain what is meant by Current Account.

Answer 3

record of all payments for trade in goods and services plus income flow it is divided into four parts.

Question 4

What four components is the Current Account split into?

Answer 4

• Balance of trade in goods (visibles)
• Balance of trade in services (invisibles) e.g. tourism, insurance.
• Net income flows. Primary income flows (wages and investment income)
• Net current transfers. Secondary income flows (e.g. government transfers to UN, EU)

Question 5

Explain what is meany by Financial Account?

Answer 5

record of all transactions for financial investment.

Question 6

Name some of the components of the Financial Account?

Answer 6

• Direct investment. This is net investment from abroad. For example, if a UK firm built a factory in Japan it would be a debit item on UK financial account)
• Portfolio investment. These are financial flows, such as the purchase of bonds, gilts or saving in banks. They include
  short-term monetary flows known as “hot money flows” to take advantage of exchange rate changes, e.g. foreign investor saving money in a UK bank to take advantage of better interest rates – will be a credit item on financial account

Question 7

Explain what is meant by the Capital Account?

Answer 7

refers to the transfer of funds associated with buying fixed assets such as land

Question 8

What are the Factors that affect the Balance of Payments?

Answer 8

• Amount of consumer spending on imports (eg. an economic boom, there will be more spending on imports, therefore creating a deficit on the current account)
• International Competitiveness (eg, higher inflation in comparison to competitors, means there is less demand for exports)
• Exchange Rates (A strong exchange rate means that a countries exports are less competitive to foreign buyers because they are more expensive)

Question 9

Evaluate the impact of a Current Account Deficit?

Answer 9

• Depends on how the deficit is financed, borrowing? (bad) or Capital Flows (hot money flows, which is better)
• Depends on the causes of the deficit, high growth or uncompetitiveness?
• Can the country devalue its currency?

Question 10

What are the Effects of a Current Account Deficit?

Answer 10

• May cause a depreciation in the exchange rate

-

Question 11

What is happening to the UK’s Balance of Payments?

Answer 11

It’s getting worse

Question 12

What affect do inflows of foreign currency have on a countries current account?

Answer 12

Are counted positively, add onto the surplus (exports)

Question 13

What affect do outflows of foreign currency have on a countries current account?

Answer 13

Are counted NEGATIVELY, add onto the deficit (imports)

Question 14

What does the Financial Account measure?

Answer 14

Measures inflows and outflows of financial capital across national boundaries

Question 15

What 4 parts is the Current Account made from?

Answer 15

• Balance of Trade in Goods
• Balance of Trade in Services
• Net Primary Income (Interest, Profits, Dividends)
• Net Secondary Income (EU Payments, Military Aid, Overseas Aid)

Question 16

What kind of things can make up the Capital Account?

Answer 16

• Sale of patents, copyrights, franchises

- Transfers of ownership of fixed assets

Question 17

Describe some major Imports of the UK.

Answer 17

• Machinery
• Vehicles
• Mineral Fuels

Question 18

Describe some major UK Exports.

Answer 18

• Gems
• Vehicles
• Machinery

Question 19

Who are the major UK Export trading Partners?

Answer 19

• USA
• Germany
• Netherlands

Question 20

Who are the major UK Import trading Partners?

Answer 20

• Germany
• USA
• China

Question 21

Describe some reasons for Current Account Surpluses and Deficits.

Answer 21

• Uneven distribution of natural resources (inc Labour)
• Exchange Rates
• Investment and Long-Term economic growth
• Domestic and government spending

Question 22

Describe some causes of a Current Account Deficit.

Answer 22

• Structural - Under investment
• Supply Side - Low Productivity
  - Persistant high inflation
  - Inadequate R&D, innovation
  - Emergence of lower cost Competition
• Cyclical - Over-valued exchange rate
• Short-term - Boom in domestic demand
  - Recession in key export market
  - Slump in global prices of exports

Question 23

What are some of the Issues of a Current Account Deficit?

Answer 23

• Loss of jobs from the export centre (multiplier effect)
• Outflow of AD from circular flow
• Fall in foreign exchange reserves - problematic for smaller developing nations
• Leads to depreciating exchange rates

Question 24

Explain the Current Account Deficit of the UK?

Answer 24

• Elasticity of Demand for Imports - Some goods are inelastic which means with a weak exchange rate consumers will continue to buy at high prices
• Growth of Emerging Markets - Due to other countries under-cutting productivity of the UK with lower costs, manufacturers move abroad to benefit from lower costs.
• Net Improter of Food and Fuel - We import highly inelastic products, necessities, which are huge imports for the UK.

Question 25

Describe some Deficit Removal Policies.

Answer 25

• Exchange Rate Policies
• Protectionism
• Government investment in Domestic Industry
• Deflationary Policy
• Supply Side Policy

Question 26

Deficit Removal Policies - Exchange Rate Policy

Answer 26

• Lower interest rates so the £ depreciates
• Domestic products are more attractive for foreign buyers, which will depreciate the exchange rate
• More attractive exports leads to increase in export sales.