International

Question 1

What are the three components of the Balance of Payments?

Answer 1

• Current account balance
• Financial account balance
• Capital account balance

Question 2

What three components make up the current account balance?

Answer 2

• Balance of trade in goods and services
• Primary income flows (profits, dividends and interest payments)
• Secondary income flows (gifts of money, charity, overseas aid and contributions to bloc budgets)

Question 3

What are the three key factors affecting the current account?

Answer 3

• Productivity (affects price competitiveness)
• Inflation relative to trading partners/ competitors
• Exchange rate (SPICED)

Question 4

What is an inward primary income flow?

Answer 4

The profits flowing into the country from a domestic MNC that has set up abroad.

Question 5

What are the three components of the financial account balance?

Answer 5

• Direct investment
• Portfolio investment (bonds and shares)
• Speculative hot money flows

Question 6

Define FDI.

Answer 6

The investment in capital assets, such as manufacturing and serve industry capacity, in a country by a business with headquarters in another country.

Question 7

Establish the link between primary income flows and capital flows.

Answer 7

Outward capital flows generate inward primary income flows in subsequent years (and vice versa).

Question 8

List three benefits of capital flows.

Answer 8

• Facilitates growth in world trade.
• Provides capital for firms that would have been unable to secure finance within their own countries.
• FDI can lead to the transfer of technology and information between countries.

Question 9

List three drawbacks to capital flows.

Answer 9

• FDI can lead to national firms becoming owned by overseas firms (change in objectives).
• Availability of international credit may lead to overborrowing by firms and government.
• One country’s financial system becomes vulnerable to the global financial system.

Question 10

What is the ‘net errors and omissions’ balancing item used for?

Answer 10

Correcting errors, delays and omissions from the balance of payments account to bring it to zero.

Question 11

How can governments finance a current account deficit?

Answer 11

• Increase the level of borrowing abroad.
• Take out savings and investments held abroad.

Able to borrow abroad as long as foreign lenders think the loans will be repaid with interest.

Question 12

When does a balance of payments crisis occur?

Answer 12

When the inward flow of capital needed to finance a current account deficit abruptly halts. Usually reflects foreign creditors’ doubts regarding the likelihood of full and timely repayment.

Question 13

Why might a trade deficit be damaging?

Answer 13

• Could indicate a lack of productivity.
• A surplus on the financing section increasing international indebtedness.
• Deflationary pressure with lower AD.
• Could indicate structural weaknesses.
• May lead to or be a result of unemployment.

Question 14

Why might a trade deficit be a good thing?

Answer 14

• Reflection of rising living standards.
• Not problematic if can finance relatively easily.
• Deficit may be due to capital goods imports, which will lead to future productivity and growth.
• May only be temporary.
• May only be a small % of GDP.

Question 15

What are the benefits to a current account surplus?

Answer 15

• Sign of competitiveness.
• Increased AD.
• Positive multiplier effects.
• Higher employment.

Question 16

What are the drawbacks to a current account surplus?

Answer 16

• Higher demand pull inflation which is problematic if close to full capacity.
• Reduces what is available for consumption now by domestic consumers (opportunity cost).
• Can cause friction between countries - can only reduce a deficit if another country reduces its surplus.

Question 17

What are the two types of policy that attempt to reduce a current account deficit?

Answer 17

• Expenditure reducing: reduce demand for imports by reducing AD.
• Expenditure switching - switching domestic demand away from imports to domestically produced goods.

Question 18

Outline the Marshall Lerner Condition.

Answer 18

When the sum of export and import elasticies is greater than unity (ignoring the minus sign), a fall in the exchange rate can reduce the deficit and a rise in the exchange rate can reduce a surplus.

Question 19

Outline the J-Curve effect.

Answer 19

In the short run, demand for imports and exports tends to be price inelastic as firms/ consumers take time to respond to changes in price. Therefore, the current account position may worsen in the short run before improving.

Question 20

Why might the J-Curve effect be short lived?

Answer 20

• Increased import prices will raise the country’s inflation rate.
• Initial worsening of BoP may reduce confidence, which leads to capital outflows that destabilise BoP and exchange rate.

Question 21

How does automatic correction fix a deficit?

Answer 21

If imports > exports, pounds are being sold so supply increases. Currency depreciates, making exports cheaper and imports more expensive.