Balance of Payments Overview

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Questions and Answers

The balance of payments is a record of all financial transactions between consumers, firms and the government from one country with other countries.

True (A)

Which of the following is NOT a component of the balance of payments?

  • Current account
  • Government account (correct)
  • Capital account
  • Financial account

What is the main difference between exports and imports in terms of their impact on the balance of payments?

Exports are considered positive, as they represent an inflow of money, while imports are considered negative, as they represent an outflow of money.

The ______ account includes all economic transactions between countries, such as trade in goods and services, income, and current transfers.

<p>current</p> Signup and view all the answers

Which of the following is an example of a current transfer?

<p>Overseas aid (C)</p> Signup and view all the answers

What is the main reason why the UK has a net current account deficit?

<p>The UK spends more on imports from foreign countries than they earn from exports to foreign countries.</p> Signup and view all the answers

What effect does a stronger currency have on the current account?

<p>It worsens the current account deficit (B)</p> Signup and view all the answers

Match the following economic factors with their respective effects on the current account:

<p>Appreciation of the currency = Worsens the current account deficit Economic growth = Worsens the current account deficit Increased foreign investment = Improves the current account surplus</p> Signup and view all the answers

What is a potential effect of a country's increased international competitiveness?

<p>Increase in exports (D)</p> Signup and view all the answers

Deindustrialisation in the UK has led to an increase in the manufacturing sector since the 1970s.

<p>False (B)</p> Signup and view all the answers

What fiscal policy measure could be implemented to help reduce a current account deficit?

<p>Increase income tax</p> Signup and view all the answers

A current account deficit indicates that there will be a capital and financial account _______.

<p>surplus</p> Signup and view all the answers

Match the following measures to their potential effects on the current account:

<p>Increasing taxes = Reduces imports Lowering interest rates = Currency depreciation Implementing green taxes = Compromises competitiveness Reducing government spending = Decreases aggregate demand</p> Signup and view all the answers

What might occur if taxes are imposed on trading partners?

<p>Possible retaliation from trading partners (D)</p> Signup and view all the answers

What is one risk associated with lowering interest rates in response to a current account deficit?

<p>Inflation in the domestic economy</p> Signup and view all the answers

Governments always have perfect information about their economies when making fiscal decisions.

<p>False (B)</p> Signup and view all the answers

What is a potential outcome of increasing spending on education and training as a supply-side policy?

<p>Increased international competitiveness (D)</p> Signup and view all the answers

Supply-side policies will always result in immediate effects on the economy.

<p>False (B)</p> Signup and view all the answers

What could be a consequence of governments providing subsidies to certain industries?

<p>Retaliation from foreign countries</p> Signup and view all the answers

A current account _____ could indicate an unbalanced economy.

<p>deficit</p> Signup and view all the answers

Match the following concepts with their implications:

<p>Current account surplus = Strong domestic economy Current account deficit = Reliance on other economies Privatization = Potential for monopolies Deregulation = Lower average costs for firms</p> Signup and view all the answers

What could happen if Chinese investors lose confidence in the US economy?

<p>Interest rates would need to be increased (D)</p> Signup and view all the answers

Fixed exchange rates allow countries to easily devalue their currency.

<p>False (B)</p> Signup and view all the answers

What is a major concern of current account deficits in the Eurozone?

<p>Inability to devalue currency</p> Signup and view all the answers

Flashcards

Balance of Payments

A record of all financial transactions between consumers, firms and the government from one country with other countries.

Imports

Goods and services bought from foreign countries, resulting in an outflow of money.

Exports

Goods and services sold to foreign countries, resulting in an inflow of money.

Current Account

Includes all economic transactions between countries such as trade in goods and services, income, and current transfers.

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Current Transfers

Transfers that have no return, such as aid and grants.

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Income Transfers

Net earnings on foreign investment and net cash transfers.

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Current Account Deficit

Occurs when a country spends more on imports than they earn from exports, leading to a net outflow of money.

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Appreciation of the Currency

A stronger currency makes imports cheaper and exports relatively more expensive, potentially worsening a current account deficit.

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Current Account Surplus

A situation where a country's exports outweigh its imports, leading to a positive balance on the current account.

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Deindustrialisation

A decrease in the size of a country's manufacturing sector, often accompanied by an increase in imports of manufactured goods.

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Fiscal Policy to Reduce Current Account Deficit

An economic policy aimed at reducing a country's current account deficit by increasing taxes and decreasing government spending.

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Lowering Interest Rates to Reduce Current Account Deficit

A reduction in interest rates by a central bank to encourage depreciation of the currency, making exports cheaper and potentially boosting exports.

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Import Price Inflation

An increase in the price of imports due to a weaker domestic currency, potentially leading to inflation.

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Hot Money

Short-term capital flows that move quickly based on interest rate differentials. This can lead to currency fluctuations and potential instability.

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Trade Taxes and Retaliation

When governments impose taxes on goods and services from trading partners, potentially leading to retaliation from those partners, reducing demand for exports.

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Interdependence in Trade

The impact of a country's economic conditions on other countries due to the interconnected nature of global trade.

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Time Lag in Policy

The delay between implementing a policy and seeing its effect on the economy.

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Over-reliance on Other Economies

A situation where a country's reliance on other economies for its growth becomes excessive.

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Deregulation

The process of reducing or eliminating government regulation in a particular industry.

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Privatisation

The process of transferring ownership of government-owned businesses or assets to private companies.

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Supply-side Policies

Measures taken by governments to influence the supply side of the economy, targeting factors like productivity, infrastructure, and skills.

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Study Notes

Balance of Payments

  • The balance of payments records all financial transactions between countries (consumers, firms, governments).
  • It shows the value of exports (goods and services sold abroad) and imports (goods and services bought from abroad).
  • Exports are a positive entry, representing an inflow of money.
  • Imports are a negative entry, representing an outflow of money.

Components of the Balance of Payments

  • Current Account: This encompasses all transactions between countries, mainly:
    • Trade in goods and services (exports and imports).
    • Income from investments abroad (e.g., salaries, dividends).
    • Current transfers (e.g., aid, grants, EU membership fees).
  • Capital Account: This involves the transfer of ownership of fixed assets.
  • Financial Account: This includes investment transactions, such as direct investment, portfolio investment, and reserve assets.

Causes of Deficits and Surpluses

  • Current Account Surplus: A net inflow of money into the circular flow of income.
  • Current Account Deficit: A net outflow of money from the circular flow of income.

UK's Current Account Deficit

  • The UK has a consistent net current account deficit. This means it imports more from other countries than it exports.
  • This can create financial difficulties if the deficit is large and persistent.

Factors Affecting the Current Account

  • Exchange Rate Appreciation: A stronger currency makes imports cheaper and exports more expensive, worsening a deficit.
  • Economic Growth: Increased consumer income often leads to increased demand for imports.
  • Increased Competitiveness: Lower inflation and economic growth in export markets can improve the current account balance.
  • Deindustrialisation: A decline in manufacturing industries (like in the UK) leads to an increase in imported goods, worsening the deficit.
  • Membership of Trade Organisations: Membership fees and contributions can generate a deficit.

Measures to Reduce Current Account Imbalances

  • Taxation: Increasing taxes to reduce disposable income and spending on imports.
  • Government Spending: Lowering government spending decreases demand and imports.
  • Fiscal Policy: Fiscal policies can be effective in the short term, but their long-term effect on the current account may be limited.
  • Regulation and Privatisation: Measures aimed at improving domestic competitiveness.
  • Supply-Side Policies: Initiatives designed to enhance productivity and exports.

Significance of Global Trade Imbalances

  • Interdependence between countries: Economic conditions in one country affect another (e.g., export markets).
  • Balance of Payments Deficits: Difficult to finance long-run deficits without attracting foreign investment, which might be unreliable in the long run.
  • Reliance on Other Countries: Vulnerability to external economic shocks or changes in foreign market conditions.

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