The Balance of Payments

Question 1

What is recorded in the nations balance of payments?

Answer 1

Economic transactions such as exports and imports of goods, services, income flows, transfers and financial flows

Question 2

Distinguish between credit and debit entries in the balance of payments

Answer 2

A credit entry is a positive entry in the balance of payments, it is an export in which income is receivable, increases foreign liabilities and is an export of currency
A debit entry is a negative entry, it is an import in which income is payable, increase in foreign assets and is an import of currency

Question 3

Explain why the balance of payments balances

Answer 3

For each transaction, there is a matching credit and debit entry. The sum of all credit entries will be exactly offset by the sum of all debit entries.

Question 4

What are the different categories that comprise the current account?

Answer 4

Goods and services, primary income and secondary income

Question 5

Provide examples of transactions in each of the categories in the current account

Answer 5

Goods: raw materials
Services: transport of goods
Primary income: compensation of employees, and investment income
Secondary income: foreign aid

Question 6

Explain why Australia usually records a current account deficit

Answer 6

Australia has generally had a current account deficit, reflecting attractive investment opportunities in the economy that exceed our capacity to fund via domestic saving I>S

Question 7

Why did Australia record a current account surplus during 2020?

Answer 7

Investment and consumption fell, there was a large decrease in imports which was a major reason for the large trade surplus. Combined with the significant fall in the income deficit, it resulted in a record current account surplus.

Question 8

Describe the change in the current account balance between 2018-20

Answer 8

Significantly increased, from deficit to surplus. The trade balance also significantly increased. The primary income balance also increased but not as much.

Question 9

What types of transactions are recorded in the financial account?

Answer 9

The financial account records the export and import of currency associated with transactions involving both trade and foreign investment

Question 10

Why does Australia normally record a financial and capital account surplus?

Answer 10

A financial account surplus means that Australia draws on the savings from the rest of the world.

Question 11

Explain why Australia recorded a financial account deficit in 2020

Answer 11

In 2020, there was a net inflow of direct investment of $1.4billion, which is normally much larger. Normally, there is also a large inflow of portfolio investment into Australia, yet in 2020, there was a net outflow of $11billion which is unusual.

Question 12

Why does Australia’s trade balance fluctuate from surplus to deficit?

Answer 12

The trade balance is volatile, and fluctuates in response to changes in domestic and global economic activity

Question 13

What is the main component of the primary income deficit?

Answer 13

Australia’s reliance on foreign investment

Question 14

Why is Australia’s primary income balance always negative?

Answer 14

Because Australia traditionally relies on foreign investment to fund Australia’s investment-savings gap

Question 15

Explain how events in the world economy can affect Australia’s current account balance

Answer 15

If the Chinese economy expands, world commodity prices rise, boosting Australia’s export income and increasing the trade and current account balance

Question 16

How is the current account balance affected by Australia’s rate of economic growth?

Answer 16

Whenever the economy expands at a rapid rate, the current account balance will decrease due to increased spending on imports, both consumption and investment goods.
When the economy slows or contracts, the current account balance will increase because spending on imports will fall relative to exports

Question 17

Explain why the current account balance follows a cyclical pattern

Answer 17

Cyclical factors help explain the fluctuations in the trade balance. The trade balance is influenced by both domestic and world business cycles.

Question 18

Explain which category in the current account is more volatile - the trade balance or primary income balance

Answer 18

The trade balance is more volatile as it is influenced by world and domestic business cycles

Question 19

What factors can lead to a fall in the current account balance?

Answer 19

A fall in the terms of trade - XPI falls relative to MPI, trade balance will fall
A fall in international competitiveness - if productivity falls or income wages rise more than productivity then exports will be less then competitiveness. A rise in inflation can also reduce competitiveness
A higher rate of economic growth - will lead to an increase in national income, consumption and investment spending, boosting demand for imports
An increase in foreign investment - increase the financial account balance
A decline in national savings - I>S = deficit
An increase in investment

Question 20

What are the structural reasons for Australia’s recording a current account deficit?

Answer 20

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Question 21

Explain how the financial account is linked to the current account

Answer 21

Foreign investment is recorded in the financial account

Question 22

Explain what would happen to Australia's current account balance for each of the following:
A mining boom
An increase in savings
A decrease in investment 
A global recession

Answer 22

A mining boom would require significant investment, decreasing the current account balance
An increase in savings, when larger than investment, the current account will record a surplus
A decrease in investment, relative to savings, would cause the current account balance to record a surplus
A global recession, would cause an increase in the rate of national savings, causing an increase in the current account balance