Balancing international payments

Question 1

Define

visible trade

Answer 1

The movement and exchange of physical exports and imports across national borders.

Question 2

Define

visible export

Answer 2

A physical product sold to consumers overseas. Payment for the product involves the receipt of money from overseas and will be credited to the current account of the balance of payments of the country receiving the product.

Question 3

Define

visible import

Answer 3

A physical product purchased from a producer overseas. Payment for the product involves the transfer of money overseas and will be debited from the current account of the balance of payments of the country receiving the product.

Question 4

Define

balance of trade

Answer 4

The difference between the value of visible exports from a country and the value of visible imports to that country, usually measured per month and annually.

Question 5

Define

trade surplus

Answer 5

This occurs when the value of visible exports from a country exceeds the value of visible imports to that country during the same period.

Question 6

Define

trade deficit

Answer 6

This occurs when the value of visible imports to a country exceeds the value of visible exports it sells overseas during the same period.

Question 7

Define

invisible import

Answer 7

The purchase of a service from an overseas producer. Payment for the service will be debited from the current account of the balance of payments.

Question 8

Define

invisible export

Answer 8

The sale of a service to an overseas resident. Payment received for the service will be credited to current account of the balance of payments of that country.

Question 9

Define

balance on services

Answer 9

The difference between the value of invisible exports from a country and the value of invisible imports to that country, usually measured per month and annually.

Question 10

Define

balance of payments

Answer 10

An accounting record of all monetary transactions between a country and the rest of the world.

Question 11

What is the structure of the balance of payments? (i.e. what is included in it)

Answer 11

• Current account balance
• Capital account balance
• Net financial account
• Net errors and ommissions

Question 12

Define

balance of payments on current account

Answer 12

This section of the balance of payments of a country is used to record and monitor how well or how badly it is performing in international trade in goods and services, and other flows of incomes and transfers with other countries.

Question 13

What is the structure of the balance of payments on current account? (i.e. what does it consist of)

Answer 13

• Balance of trade
  
  • ​visible exports - visible imports
• Balance on services
  
  • ​invisible exports - invisible imports
• Balance on income
  
  • ​income credits - income debits
• Net current transfers

Question 14

What do income credits and income debits include?

Answer 14

Income credits:

• wages paid to residents working overseas
• interest and dividends earned by residents and firms on investments they have in other countries

Income debits:

• wages paid to overseas residents working in the economy
• any interest, profits and dividends paid out to overseas residents and firms who have invested in the economy

Question 15

What will credits in current transfers include?

Answer 15

• girfs of money, charitable donations and pension payments received from the residents of other countries
• taxes and excise duties paid by residents on other countries on goods and services produced in the economy
• overseas aid and other payments made from other governments
• any grants or refunds of contributions received from international organisations

Question 16

What will debits in current transfers include?

Answer 16

• gifts of money, charitable donations and pension payments paid to the residents of other countries
• taxes and excise duties paid by US residents on goods and services purchased overseas
• overseas aid and other payments made to the governments of other countries
• membership contributions to the budgets of international organisations such as the International Monetary Fund and World Trade Organisation

Question 17

Define

capital account

Answer 17

A country’s record of international capital transfers for the acquisition, disposal or transfer of non-financial assets including land, factories, office buildings and machinery, between its residents and the rest of the world.

it also records the cancellation of debts between countries, the transfer of goods and financial assets by migrants leaving or entering a country and any payments of gifts and inheritance taxes they may make.

Question 18

Define

financial account

Answer 18

A country’s record of international monetary flows related to investment in business, real estate, bonds, loan stocks and company shares (any interest, profits and dividends from these investments are recorded as incomes in the current account).

Also included are government-owned assets (namely gold and foreign currency).

A country receives direct inward investment whenever a foreign-owned firm sets up a factory, office or retial outlet in it.

Question 19

Define

exchange rate

Answer 19

The equilibrium market price of one national currency in terms of another currency established through trade in currencies on the foreign exchange market.

Question 20

Define

foreign exchange market

Answer 20

The global market for the exchange of national currencies.

Question 21

Define

floating exchange rate

Answer 21

The market price of a national currency against another currency that is determined on the foreign exchange market by the supply and demand for that particular currency.

Question 22

Define

appreciation

Answer 22

A rise in the rate at which a national currency can be exchanged for another currency or currencies, i.e. a rise in the market price of one currency in terms of other currencies.

Question 23

Why might a currency appreciate?

Answer 23

• There is a balance of payments surplus
• Demand for the currency rises as overseas consumers buy more exports
• Interest rates rise relative to other countries. This attracts savings from overseas residents (‘hot money’)
• Inflation is lower than in other countries so exports will be cheaper and overseas demand for them, and the currency required to pay for them, will rise
• People speculate the currency will rise in value and buy more of the currency

Question 24

Define

depreciation

Answer 24

A fall in the value of a floating exchange rate of a currency against another foreign currency.

Question 25

Why might a currency depreciate?

Answer 25

• There is a balance of payments deficit
• Demand for other currencies rises as domestic consumers buy more imports
• Interest rates fall relative to other countries. People move their savings to bank accounts overseas
• Inflation rises relative to other countries. This makes exports more expensive and demand for them, and the currency needed to buy them, falls
• People speculate the currency will fall in value and sell their holdings of the currency

Question 26

How do changes in exchange rates affect product prices?

Answer 26

A fall (depreciation) in the exchange rate of a currency will make imports to that country more expensive but will lower the price of its exports in overseas markets.

A rise (appreciation) in the exchange rate of a currency will make imports to that country cheaper but will increase the price of its exports in overseas markets.

Question 27

Define

managed floating (a.k.a. dirty floating)

Answer 27

A floating exchange rate system that is partially controlled by government through the sale or purchase of its currency reserves to limit an appreciation or depreciation in the value of its national currency.

Changes in interest rates can also help to manipulate the exchange rate as it influences the incentives of overseas investors

Question 28

List the problems of having a trade deficit

Answer 28

• It may be the result of industrial decline in the economy
• It means more income is leaving the economy, leaving less to spend on domestic goods and services
• The value of the currency will fall on the foreign exchange market making imports more expensive (imported inflation will occur)
• To pay for recurrent deficits a country may have to borrow from overseas. This will increase the public debt and total interest charges, as well as harming economic growth

Question 29

In which ways may a government attempt to correct a trade deficit?

Answer 29

• Do nothing, because a floating exchange rate should correct it
• Use contractionary fiscal policy (reduces aggregate demand so people spend less on imports)
• Raise interest rates to attract more inward investment and reduce spending on imports
• Introduce trade barriers

Question 30

List the problems of having a trade surplus

Answer 30

• Other countries may put political and economic pressure on the government to reduce the trade surplus so they can reduce their trade deficits
• The boost in income from trade may cause a demand-push inflation when it is spent in the domestic economy
• The value of the currency will rise on the foreign exchange market and stay high. This will increase the price of exports overseas, resulting in falling demand and job losses
• A persistent trade surplus may itself be a symptom of rapid industrial expansion

Question 31

In which ways may a government attempt to correct a trade surplus?

Answer 31

• Do nothing, because a floating exchange rate should correct it
• Use expansionary fiscal policy (boost aggregate demand)
• Lower interest rates (encourages increased spending on imports, reduces inward investment)
• Remove trade barriers