The balance of payments

Question 1

What is the balance of payments?

Answer 1

The balance of payments is a record of all financial transactions made between a country and the rest of the world, divided into the current, capital, and financial accounts.

Question 2

What are the three main components of the balance of payments?

Answer 2

The balance of payments includes the current account, capital account, and financial account.

Question 3

What does the current account measure?

Answer 3

The current account measures trade in goods and services, primary income (e.g., income from investments), and secondary income (e.g., transfers like foreign aid).

Question 4

What are the main components of the current account?

Answer 4

Trade in goods: exports and imports of physical items.
Trade in services: exports and imports of services like tourism and banking.
Primary income: earnings from investments and wages abroad.
Secondary income: transfers like foreign aid and remittances.

Question 5

What does the capital account track?

Answer 5

Capital transfers: large, one-off financial transactions like debt forgiveness.
Non-produced, non-financial assets: transactions involving items like patents, trademarks, and mineral rights.

Question 6

What are the main components of the financial account?

Answer 6

Foreign Direct Investment (FDI): long-term investments where investors have control, like buying foreign businesses.
Portfolio investment: investments in foreign securities, such as stocks and bonds, without control.
Other investment: loans, deposits, and other financial flows.
Reserve assets: foreign currency reserves held by the central bank to manage exchange rates.

Question 6

What is the difference between the capital account and the financial account?

Answer 6

The capital account records capital transfers and acquisition/disposal of non-produced, non-financial assets, while the financial account tracks investments, including foreign direct investment (FDI) and portfolio investment.

Question 7

What is a current account deficit?

Answer 7

A current account deficit occurs when a country imports more goods, services, and income flows than it exports, resulting in an outflow of currency.

Question 8

What is a current account surplus?

Answer 8

A current account surplus occurs when a country exports more than it imports, resulting in a net inflow of currency.

Question 9

What factors influence a country’s current account balance?

Answer 9

Factors include productivity, inflation, and the exchange rate. High productivity boosts exports, low inflation makes exports cheaper, and a weaker currency also boosts exports by making them more competitive.

Question 10

What is the difference between Foreign Direct Investment (FDI) and portfolio investment?

Answer 10

FDI involves long-term investment in businesses or assets in another country, giving control or influence, while portfolio investment involves buying financial assets like stocks or bonds, without direct control.

Question 11

What are the consequences of investment flows between countries?

Answer 11

Investment flows can impact exchange rates, stimulate growth, and increase employment. However, they may also lead to economic dependence on foreign capital and volatility in financial markets.

Question 12

What are expenditure-switching policies?

Answer 12

Expenditure-switching policies aim to shift spending from foreign to domestic goods, often using tariffs, subsidies, or devaluation of the currency to make domestic goods more attractive.

Question 13

What are expenditure-reducing policies?

Answer 13

Expenditure-reducing policies aim to lower overall spending in the economy to reduce imports, typically using fiscal or monetary tightening (e.g., higher taxes or interest rates).

Question 14

How might policies to correct a balance of payments deficit affect other macroeconomic objectives?

Answer 14

Policies like raising interest rates to reduce spending can curb inflation but may increase unemployment and reduce economic growth.

Question 15

Why might a persistent current account deficit be concerning for an economy?

Answer 15

A persistent deficit may lead to increased foreign debt, currency devaluation, and a reliance on foreign capital, potentially making the economy vulnerable to global shocks.

Question 16

What are the implications for the global economy if a major economy takes corrective action on imbalances?

Answer 16

If a major economy reduces a large deficit or surplus, it could affect global trade and capital flows, potentially causing currency fluctuations, changes in global demand, and adjustments in other countries’ policies.