Week 20 balance of payments

Question 1

Balance of payments definition

Answer 1

Question 2

current account definition

Answer 2

investment income is the income earnt by the assets owned by our own citizens or UK assets owned by foreigners

transfers into and out of a country - debt, aid

Question 3

financial account definition

Answer 3

Question 4

what 3 flows does the current account record between the UK and other countries

Answer 4

Question 5

current account balance

Answer 5

rarely occurs

Question 6

current account surplus

Answer 6

Question 7

who lends the money example of UK and Rest of the World

Answer 7

Current a/c:
Uk overspend so have to borrow
R o W have a surplus so save

Financial a/c
UK borrow so injection
RoW save so leakage

ends up balancing
= balance of payments

Question 7

current account deficit

Answer 7

Question 8

what is a the trade balance

Answer 8

trade of goods and trade of services

Question 9

what can the current account be split up into

Answer 9

1) trade balance
2) income balance

Question 10

what is income balance

Answer 10

investment income and transfers

Question 11

what 3 things makes up the financial account
good to remember for exam

Answer 11

if usa buy uk bonds = inflow (vice versa)

Question 12

3 demand-side reasons for a current account deficit

Answer 12

Question 13

how does the 3 demand-side issues cause a current account deficit

Answer 13

1) strong domestic growth
>AD increases, incomes are high, living standards are high
–> people want to consume more and therefore imports increase

2) Recessions
> incomes abroad falling, exports decrease
–> revenue from exports falls so worsens trade balance

3) strong exchange rate , SPICE
> Imports cheaper, exports dearer
–> worsens trade balance

Question 14

what determines supply-side reasons for a current account deficit

Answer 14

all to do with cost of exports and competitiveness of exports

Question 15

4 supply-side issues with the competitiveness of exports for current account deficit

Answer 15

1) low investment
2) low productivity
3) high relative inflation
4) high unit labour costs

Question 16

what are 2 supply-side issues with the cost of exports for current account deficit

Answer 16

1) poor quality/ reliability
2) depletion of resources

Question 17

evaluation for causes of current account deficit

Answer 17

supply-side reasons are much more destructive then demand-side

because they can be long-term

Question 18

why has the UK had such a big current account deficit for so long

Answer 18

mainly caused by supply-side reasons which are long-term and hard to recover from

can’t just change over time

Question 19

3 consequences of of current account deficit

Answer 19

1) lower AD
> u/e increases, PL decreases and output decreases

2) debt burdens - rack up loads of debt to finance deficit (only if CA deficit is large % of GDP)
> investers may lose confidence in ability to pay debt back
–> I decreases, citizens worry about how debt will be financed as no income stream, people sell currency (depreciation)
—-> multiplier effect > currency crisis as debt and savings lose value > leads to economic crisis

3) fall in exchange rate
> import more than export supply of currency increases
–> WPIDEC
—> could correct CA deficit if exports are competitive
—-> UK exports are not competitive so will be effected by increased import prices effect producers leads to stagflation

Question 20

stagflation definition

Answer 20

persistent high inflation combined with high unemployment and stagnant demand in an economy

Question 21

Evaluation for consequences of a current account deficit

Answer 21

1) if deficit is small percentage of GDP like UK and US has little effect on AD

2) good consequence would be signs of domestic growth to have a CA deficit

3) supply-side vs demand-side (supply-side long term and damaging)

4) what if it is income balance that causes CA deficit

Question 22

expenditure reducing policies to reduce CA deficit

Answer 22

all about reducing incomes, which reduces AD and imports

Question 23

Evaluation of expenditure reducing policies to reduce CA deficit

Answer 23

1) conflicting objectives - u/e increases, growth decreases, potential recession and inflation may go below target

2) too high consumer and business confidence causes AD not to fall

3) economy is at full employment a reduction in AD won’t effect incomes to fall that much

4) Marginal propensity to import not that high reducing incomes won’t effect incomes enough to reduce imports

Question 24

2 expenditure switching policies to reduce CA deficit

Answer 24

switching spending on imports to spending on domestic goods

> through protectionism more spending on domestic goods by making imported goods more expensive

> through lowering exchange rate (Central bank - decrease interest rates or selling domestic currency reserves
government: increase money supply > quantitive easing)

Question 25

5 evaluation points on switching expenditure policies to reduce CA deficit - protectionism

Answer 25

1) retaliation may lead to less revenue made from exports than costs saved from protection on imports

2) may go against WTO rules of free trade (heavy fines)

3) can be cost-push inflation from greater costs of imports and cost to produce from that (raw materials)

4) higher consumer prices on imports

5) loss of efficiency (loss of world efficiency on tariff diagram) and (firms may get lazy due to less competitiveness needed due to being helped by protectionist policies)

Question 26

3 evaluation points on switching expenditure policies to reduce CA deficit - lowering exchange rates

Answer 26

1) marshall lerner condition

2) inflationary pressure (demand-pull as AD shifts outwards, or cost-push as raw materials cost more to import)

3) retaliation and currency war (lowering exchange rate is like a protectionist measure so other countries do the same therefore no one benefits from lowered exchange rate)

Question 27

how do supply-side policies improve the CA deficit

Answer 27

boosts international competitiveness such as spending on education, infrastructure and subsidising R and D

all reduce the costs to produce and allow cheaper export prices making them more competitive

does 2 things:
1) improves export revenue and performance
2) switches consumers from imported goods to domestic goods because more competitive (cheaper)

Question 28

4 evaluation points on supply-side policies to improve the CA deficit

Answer 28

1) takes a long time
2) very costly and high opportunity cost
3) no guaranteed success
4) has to be heavily targeted (only solves one issue at a time like labour productivity

Question 29

when should supply-side policies be used to improve the CA deficit

Answer 29

mainly for supply-side causes of the deficit which are much more long-term and hard to improve like labour productivity

Question 30

what is the marshal lerner condition

Answer 30

Question 31

why does the marshal lerner condition not hold in the SR

Answer 31

in SR demand is inelastic for consumers and producers importing as it take time to adjust to change in prices (is it going to be long term)
-> same for exporters

this is shown on the J-curve

Question 32

What is the J curve

Answer 32

CA worsens at first as it takes time to adjust and realise change in prices due to WPIDEC then after it improves

Question 33

quantitive easing to increase money supply to depreciate value of currency

Answer 33

Question 34

what are the 2 types of causes for a CA surplus

Answer 34

demand-side and supply-side

Question 35

what are the 3 demand-side causes of CA surplus

Answer 35

Question 36

what are the 5 supply-side causes of CA surplus

Answer 36

first 3 to do with competitiveness of exports

last two to do with costs of exports

Question 37

what are 5 consequences of a CA surplus

Answer 37

ii) CA surplus may not last long if currency appreciates

iii) financial account deficit as country saves money from exporting more than importing > they can then fund debt of countries in a deficit, but if they can’t pay debt back = lost money

iV) can lead to retaliation if CA surplus is achieved through artificial measures like protectionism