Disequilibrium in the Balance of Payments

Question 1

What reasons can a surplus be bad?

Answer 1

Inflationary Pressures
Exchange Rate Distortions
Global Imbalances
Resource Misallocation

Question 2

How does a surplus cause inflationary pressures?

Answer 2

A sustained surplus means an excess inflow of foreign currency, which can increase domestic money supply leading to inflation

Question 3

How does a surplus cause exchange rate distortions?

Answer 3

A large surplus leads to currency appreciation. Overvalued currencies harm export competitively causing more imports leading to trade imbalance

Question 4

How does a surplus cause global imbalances?

Answer 4

Surpluses in a country may mirror deficits in others. This destabilises the global economy and causes tensions

Question 5

How does a surplus cause resource misallocation?

Answer 5

Surpluses used by excessive saving or under-consumption indicates misallocation of resources and low domestic welfare

Question 6

What is a disequilibrium in the balance of payments?

Answer 6

Where credit exceed debit or debit exceeds credit

Question 7

What are the causes of a surplus in the balance of payment?

Answer 7

High Export Levels
Low Import Levels
Strong Remittance Inflows
High Income from Investments
Large Capital Inflows
Exchange Rate Policies
Favourable External Conditions

Question 8

How do high export levels cause a surplus in the balance of payments?

Answer 8

Competitive Exports
Strong Global Demand

Question 9

How do low import levels cause a surplus in the balance of payments?

Answer 9

Protectionist Policies and trade restrictions limit imports
Domestic Substitution means countries produce enough so rely less on imports
Weak Domestic Demand require fewer imports

Question 10

How do strong remittance inflows cause a surplus in the balance of payments?

Answer 10

Income sent from working citizens abroad increase inflows leading to a surplus

Question 11

How do high income from investments cause a surplus in the balance of payments?

Answer 11

Foreign Investment Returns from interest, dividends, or profits, increase income flows

Question 12

How do large capital inflows cause a surplus in the balance of payments?

Answer 12

Foreign Direct Investment create surplus in the capital/financial account
Portfolio Investments from foreigners in financial assets boost the capital account
Loans or Aid from foreign lenders or international aid add to capital inflows

Question 13

How do exchange rate policies cause a surplus in the balance of payments?

Answer 13

Undervalued currency makes exports cheaper

Question 14

How do favourable external conditions cause a surplus in the balance of payments?

Answer 14

Global Commodity Prices may run surpluses due to high global prices
Trade Agreements boost export access to foreign markets

Question 15

What are causes of deficit in balance of payments?

Answer 15

Population Growth
Development Programmes
Demonstration Effect
Inflation
Economic Growth
Recession in Trading Partners
Overvalued Exchange Rate

Question 16

How does population growth cause a deficit?

Answer 16

To meet the needs of a growing population, it may require imports causing a deficit

Question 17

How does economic growth cause a deficit?

Answer 17

Economic growth causes a rise in incomes, of which a proportion will be spent on imports

Question 18

How do development programmes cause a deficit?

Answer 18

Developing countries need to import capital, raw materials. The development programmes behind this require imports

Question 19

How does the demonstration effect cause a deficit?

Answer 19

People in less developed countries imitate consumption patterns of the people in developed countries, so their imports increase

Question 20

How does inflation cause a deficit?

Answer 20

If UK inflation rises faster than competitors, UK exports become less attractive causing a deficit

Question 21

How does a recession in trading partners cause a deficit?

Answer 21

Economic downturns in key trading partners reduce demand for UK exports

Question 22

How does an overvalued exchange rate cause a deficit?

Answer 22

An overvalued currency makes a country’s exports more expensive and negatively impacts the trade balance

Question 23

What are the 3 exchange rates?

Answer 23

Floating
Fixed
Managed/Dirty Floating

Question 24

What are the floating exchange rates?

Answer 24

Floating exchange rates are flexible and those that are affected by demand and supply

Question 25

What are fixed exchange rates?

Answer 25

Fixed exchange rates remain constant

Question 26

What are managed/dirty floating exchange rates?

Answer 26

Managed/Dirty Floating exchange rates is were the central bank intervenes when necessary

Question 27

What are the measures used to correct a deficit in the balance of payments?

Answer 27

Deflation Exchange Depreciation Devaluation Exchange Controls Tariffs Quotas Export Promotion Import Substitution

Question 28

How does deflation correct a deficit?

Answer 28

Deflation makes UK exports cheaper in foreign markets resulting in a rise in UK exports Moreover, the demand for imports fall due to higher taxation and reduced income

Question 29

How does exchange depreciation correct a deficit?

Answer 29

Exchange depreciation means decline in the rate of exchange. This stimulates exports and reduces imports as exports become cheaper and imports are more costly

Question 30

How does devaluation correct a deficit?

Answer 30

Devaluation is the deliberate attempt made by monetary authorities It has the same affect as exchange depreciation

Question 31

How does exchange control correct a deficit?

Answer 31

Governments implement controls to restrict foreign exchange outflows. Policies can limit the amount of foreign currency people can access, reducing imports and encouraging domestic production

Question 32

How do tariffs correct a deficit?

Answer 32

Tariffs are imposed on imports increasing their price and reducing their demand

Question 33

How do quotas correct a deficit?

Answer 33

The government may fix and permit the maximum quantity and value of a commodity to be imported during a given period

Question 34

How does export promotion correct a deficit?

Answer 34

The government promote export by providing required administrative and diplomatic help to tap potential markets

Question 35

How does import substitution correct a deficit?

Answer 35

Import substitution reduces the volume of imports and make it self-reliant using fiscal and monetary measures to encourage industries

Question 36

How do interest rates correct a deficit?

Answer 36

Raising interest rates means that borrowing becomes expensive, reducing demand and consequentially the demand for imports

Question 37

What are the measures for correcting a surplus in the balance of payments?

Answer 37

Currency Appreciation Boosting Domestic Consumption and Investment Liberalising Imports Reducing Capital Inflows

Question 38

How does currency appreciation correct surplus?

Answer 38

Currency appreciation reduces export competitiveness and makes import cheaper

Question 39

How does boosting domestic consumption and investment correct surplus?

Answer 39

Governments stimulate domestic demand through fiscal policies, increased public spending, tax cuts and encouraging consumers

Question 40

How does liberalising imports correct a surplus?

Answer 40

Reducing barriers to import can increase inflow of goods and services, offsetting export surpluses

Question 41

How does reducing capital inflows correct a surplus?

Answer 41

Governments can implement policies to limit capital inflows that add to financial account surpluses