LS7- Balance of Payments

Question 1

3 components of the Balance of Payments

Answer 1

• trade balance
• capital account
• financial account
• the balance of payments account must always be neutral - components may be positive or negative
• a balance on the current account account of the balance of payments is a macro gov objective

Question 2

Current account

Answer 2

• records the transactions related to a country’s trade in goods, services, income, and transfers

Question 3

Examples of services, income and transfers from current account

Answer 3

• services - tourism, financial services, consulting
• income - dividends, interest from foreign investments
• transfers - foreign aid, gifts

Question 4

Capital account

Answer 4

• records financial transactions that involve the acquisition or disposal of non-financial assets such as real estate and copyrights between a country and the rest of the world
• also includes capital transfers e.g. transfer of assets for specific purposes like debt forgiveness

Question 5

Financial account

Answer 5

• records transactions related to financial assets and liabilities including FDI and foreign exchange reserves

Question 6

Problems of current account deficit + eval

Answer 6

• aggregate demand is reduced - depends on size of deficit + causes of deficit
• debt burden increases - depends on how sustainably current account is financed

Question 7

Problems of current account surplus + eval

Answer 7

• indicator of heavy reliance on exports - depends on size of surplus, could be good if it’s the product of successful supply-side policies
• can be detrimental to the economies of trade partners - depends on AD of trade partners’ economies (bigger problems for economies with limited fiscal space)

Question 8

What is meant by ‘limited fiscal space’?

Answer 8

• their fiscal situations don’t allow them to raise spending or cut taxes as a way of stimulating domestic demand

Question 9

Methods to reduce a deficit on the current account of the balance of payments

Answer 9

• expenditure reducing policies - contractionary monetary policy, contractionary fiscal policy (fall in AD and incomes -> reduced spending on imports)
• protectionism - tariffs, quotas, embargos, subsidies (increases cost of imports)
• supply-side policies - infrastructure spending, education & training spending, tax cuts (improves exports through quality innovation)