The balance of payments

Question 1

e.g.

Define the balance of payments (BoP)

Answer 1

Record of all international transactions made between one country, and the rest of the world

Question 2

What are the 3 accounts/parts of the BoP?

Answer 2

1. Current account
2. Financial account
3. Capital account

(these 3 parts must balance out in the end)

Question 3

The current account (of the BoP) compromises
in what 4 things?

Answer 3

1. Trade in goods
2. Trade in services
3. Primary income
4. Secondary income / transfers

(we look at the current account when we are trying to measure trade)

Question 4

What is meant by the trade balance?

Answer 4

• trade in goods + trade in services
• exports - imports

Question 5

Define currenct account?

Answer 5

Measures the total value of export revenue and import expenditure of trade in goods and services, investment income and current transfers

Question 6

What does primary income measure?

Answer 6

• It measures the monetary flows generated from the owning of international financial assets, known as investment income
• It represents the returns from UK investments abroad and that of foreign-owned investment in the UK
• i.e. it measures income entering and income leaving the country

Question 7

Give an example of primary income

Answer 7

Income on Direct Investment: includes profits, dividends, and interest earned by residents from their direct investments in foreign companies and vice versa

Question 8

What does secondary income/ transfers measure?

Answer 8

It measures the flow of funds between countries without an exchange of goods or services

Question 9

Give 2 examples of secondary income/transfers

Answer 9

1. Remittances: Money sent by foreign workers back to their home countries
2. Foreign aid
3. Grants

Question 10

What is the financial account (of the BoP)?

Answer 10

It includes transactions that result in a change of ownership of financial assets and liabilities between a country’s residents and non-residents.

Question 11

Give some transactions that would be recorded in the financial account

Answer 11

1. FDI
2. Portfolio investment

Question 12

Define portfolio investment

Answer 12

refers to buying financial assets like stocks, bonds, or other securities, issued by entities in another country

Question 13

Give 3 examples of portfolio investment

Answer 13

• corporate shares and bonds
• government bonds
• hot money

Question 14

What is the capital account (of the BoP)?

Answer 14

Accounts for international transactions which are very minor e.g. debt forgiveness, inheritance tax, death duties

Question 15

What is a current account deficit?

Answer 15

• Occurs when a country’s total imports of goods, services, income, and transfers exceed its total exports
• It implies that a country is spending more on foreign trade than it is earning

Question 16

What is a current account surplus?

Answer 16

• Occurs when a country’s total exports of goods, services, income, and transfers exceed its total imports
• It implies that the country is earning more on foreign trade than it is spending internationally

Question 17

What are the 2 types of causes of current account deficit/surplus?

Answer 17

1. Cyclical (short-term & demand-side)
2. Structural (long-term & supply side)

Question 18

Define stagflation

Answer 18

An economic situation where there is reducing growth and high inflation at the same time

Question 19

Countries with a current account deficit must balance it by running what? for example?

Answer 19

By running an equal value financial account surplus e.g. by borrow from international investors

Question 20

Define a currency crisis

Answer 20

Currency loses value rapidly

Question 21

How does a current account surplus put an upward pressure on the exchage rate (demand for currency > supply of currency )?

Answer 21

• When there is a CAS, it means a country is exporting more goods and services than it imports
• This surplus creates a higher demand for the country’s currency from other countries to pay for those exports
• When demand for a currency increases, its value goes up in comparison to other currencies
• So, a CAS puts upward pressure on the exchange rate

Question 22

What are expenditure - reducing policies?

Answer 22

These are contractionary monetary and fiscal policies designed to lower real incomes and AD in the economy, thereby cutting the demand, and therefore the spending on imports

Question 23

What are expenditure - switching policies?

Answer 23

policies designed to change the relative prices of exports and imports
e.g. money that was being used to spend on imports, can be switched to spend on domestic goods instead

Question 24

What is the difference between expenditure - reducing policies and expenditure - switching policies?

Answer 24

• Expenditure-reducing policies - aims to reduce overall spending on imports
• Expenditure-switching policies - aims to redirect spending towards domestic goods

Question 25

What is the Marshall-Lerner condition?

Answer 25

It states that a currency depreciation (WIDEC) will only correct a CA deficit if PEDx + PEDm > 1

Question 26

What is the J curve effect?

Answer 26

* It shows the possible **time lags** between a falling currency and an improved trade balance * Initially the CAD will worsen before it improves