How Is International Trade Recorded And Financed?

Question 1

What is the relationship between the current account and the capital and financial account?

Answer 1

Always equal and opposite

Question 2

What goes under the current account?

Answer 2

• trade in goods
• trade in services
• net income flows ( eg profit, dividends, interest)
• net current transfers (eg foreign aid, eu contributions

Question 3

What comes under the capital and financial account?

Answer 3

• long term capital flows ( FDI FPI)

- short term capital flows ( hot money flows, other loans

Question 4

What are net errors and omissions?

Answer 4

Included to make bop accounts balance. Takes into account errors that have been made in compiling the accounts due to the complexity

Question 5

What are the 4 main causes of a current account deficit?

Answer 5

1) strong currency- imports cheaper exports dearer
2) economic growth- more disposable income UK high marginal propensity to imports
3) decline in international competitiveness
4) higher inflation- exports less competitive imports more competitive
5) recession in other countries

Question 6

What is the bop?

Answer 6

A record of all the financial transactions between one country and the rest of the world

Question 7

What are the 4 main problems with having a persistent current account deficit ?

Answer 7

1) it leads to a loss of AD and slower growth
2) can lead to a loss of jobs in home based industries
3) can lead to currency weakness and higher inflation
4) currency weakness can lead to capital flight/ loss of investor confidence

Question 8

When is a current account deficit not a problem?

Answer 8

1) when it can easily be financed by attracting money from abroad
2) low percentage of GDP
3) short term problem
4) an easy fix eg controlling inflation
5) if it is caused by importing capital goods which could lead to higher production and exports of goods in the future

Question 9

What are bilateral exchange rates?

Answer 9

Value of one currency compared o another

Question 10

Reasons for a surplus

Answer 10

• have a factor endowment in high demand by the rest of the world
• largely self sufficient ( low marginal propensity to import)
• high international competitiveness
• comparative advantage in high value goods
• weak currency
• relatively low inflation
• economic growth in other countries creates more demand for exports

Question 11

Reasons for deficit

Answer 11

• low productivity
• CA in low value goods
• high propensity to import
• lack of international competitiveness
• high levels of consumer spending
• strong currency
• de-industrialisation

Question 12

What are 4 policies to correct a BOP current account deficit?

Answer 12

• supply side policies improve competitiveness
• expenditure reducing policies to reduce AD in order to reduce spending on imports
• expenditure switching policies designed to increase spending on exports and reduce spending on imports
• do nothing ( free floating exchange rate system)

Question 13

Why might a surplus be a bad thing?

Answer 13

• building up large quantities of foreign currency

- lower living standards as goods are exported rather than consumed

Question 14

What are the 5 key factors that cause movements in exchange rates?

Answer 14

• FDI
• trade (current account balance)
• relative inflation rates
• speculation
• relative interest rates

Question 15

What is the theory behind the J Curve?

Answer 15

A depreciation of the currency should raise the current account deficit back towards the equilibrium. Fall in exchange rate -> rise in exports & fall in imports

Question 16

Why according to the J Curve does the current account deficit worsen in the long run?

Answer 16

Demand for exports and imports inelastic, therefore amount spent on exports decreases and amount on imports increases

Question 17

What is the Marshall Lerner condition?

Answer 17

• a currency depreciation will only correct BOP current account deficit if combined PEDs of exports and imports is greater than 1
• if the result is less that 1 a depreciation will worsen the deficit