Ch17- The Balance of Payments

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Define the Balance of Payments
A set of accounts recording transactions over a period of time between economic agents of one country and all of the others
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What 3 sections is the B of P split into?
1)Current Account 2)Financial Account 3)Capital Account
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What are the 4 components of the current account?
1)Trade in goods- 'visibles' 2)Trade in services- 'invisibles' 3) Investment income- interest/profits/dividends from assets abroad 4)Transfers- sum of money given without corresponding value of goods and services e.g. repatriation
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What is the financial account?
Short-term and long-term capital flows, consisting of FDI, net portfolio investment and 'hot money'
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If we ran down reserve assets in B of E, what sign would it be on financial account?
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What are short-term capital flows?
Short-term flows of money which go from country to country in search of stability, higher interest rates and speculation of a rise in value of currency.
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What are long-term capital flows? (2 types)
1)Real investment- acquisition of productive assets e.g. building a factory 2)• Portfolio investment -the acquisition of financial assets e.g. buying stocks and shares
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What is the capital account? (less significant)
purchase/sale of patents, trade-marks and land for foreign embacies and transfer of capital by foreign workers, along with government transfers including some types of foreign aid.
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Which two accounts are interdependent?
The current account and the financial account
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Why are they interdependent? e.g. if there's a current account deficit
- need a financial account surplus to provide the foreign exchange to pay for excess imports
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How could the surplus on the financial account be created? is this sustainable? hence?
Through running down reserves, inward FDI or loans from foreigners --> UNSUSTAINABLE - Hence gov. will aim for long-run equilibrium on current acc.
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If there is a current account surplus...
...the economy will be accumulating foreign exchange used to build up reserves and buy assets
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Give data to support the importance of the city of london to the trade in financial services. (3 pieces of data)
1/4 of London's contribution to GDP is in financial services. (it has the largest city GDP in Europe) Over 80% of European hedge funds are managed in UK. In 2006, 10% of UK's exports were from financial services from London.
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What is London's success in financial services due to? (5)
1)Location (halway between America + Asia) 2)TIme zones- GMT 3)Taxes only money earns in UK, whereas US tax on global earnings- encourages people to live here! 4)'business language' 5)reputation of our legal system
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What have the negative impacts of London's success been?
property prices soared --> first time buyers forced to buy with friends or take out risky 100% mortgages. -->created gap between rich city and rest of country
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What should be noted about 'The City's' success?
Whilst London is booming, most successful firms in square mile aren't actually British- mostly american or swiss.
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What are the benefits of London's success?(4)
1)Investment funds sink capital into forward-looking companies- could end up enhacing our lives e.g. Windsave 2)bolsters cultural life (sponsers high arts) 3)filled gap left by declining manufacturing 4)reduces c/a deficit by exporting services
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link the balance of payments to economic activity in 3 ways...
1)exports = an injection leading to multiplier effect 2)imports = a leakage 3) (X-M) = component of AD
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What is international competitiveness?
The ability to sell goods and services in world markets
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What is competitiveness determined by other than price? (6) (ALL RELATIVE)
1) Perceived quality 2)Branding 3)Delivery Dates 4)Reputation 5)After-sale service + availability of parts 6)Time zones + language (particularly useful in services)
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What is the price of an export to another country determined by?
1)Subsidies 2)Exchange rate 3)Costs of production 4)Productivity 5)inflation rate 6)protectionism (can make efficiently produced goods unable to compete)
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Give 4 factors affecting imports and exports.
1)Trade policy of our nation + other nations 2)political stability 3)national income and growth rates- MPI must also be considered 4)raw material, energy and component needs
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How can an import tariff actually worsen our current account in the long run?
Costs of production are pushed up, cost push inflation caused, our goods become less price competitive
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Give 6 causes of a current account deficit (2 on this card)
1)High economic growth- 'sucks in' imports as consumers increase spending (UK has a fairly high MPI)- also as economy nears full employment, domestically produced goods cannot satisfy demand alone, so import more! 2)A strong £- exports more expensive
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3)Low growth of trading partners- reduced demand for exports 4)lack of competitiveness of british goods (growth of developing economies has increased competition as have comparative advantage (and with superior quality such as mittlestand in germany)
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5)falling surplus in UK's oil trade 6)high inflation compared with trading partners
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Give 5 reasons why a current account deficit might not matter
If its... 1)a small proportion of our national income 2)cyclical 3)allows a country to enjoy a higher standard of living than it would have otherwise 4)if country is using imports to build up productive capacity for future 5)its temporary
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Give 5 reasons why a current account deficit might matter
If its... 1)a large proportion of our GDP 2)causes a large reduction in AD + hence unemployment in export industries 3)not followed by surplus 4)structural e.g. weakness in manufacturing 5)may lead to protectionism- moves away from comparative adv.
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How might a deficit be financed?
1) running down reserves 2)borrowing 3)inward investment
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What are the 2 types of short-term methods in curing a current account deficit?
1)expenditure switching 2)expenditure reducing
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How does an expenditure reducing policy work?
Deflationary fiscal and monetary policies to reduce AD, hence lowering consumption and less imports are bought. 2
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a)When is this policy most succesful? b)when has it been used before? c)what are its drawbacks?
a)when MPI is high b)in late 60's when UK had a fixed exchange rate and a series of c/a crises 3)reduces investment, which reduces competitiveness in future years
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What are the two types of expenditure switching policies?
1)protectionism- use of tariffs, quotas, subsidies, and exchange controls 2)devaluation/depreciation of exchange rate
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Give 5 reasons why protectionism is a bad policy... (1-3)
1)will result in retaliation 2)if import prices rise, will lead to cost push inflation and hence in LR doesn't help our competitiveness 3)moves away from theory of comparative adv. (hence lowering living standards)
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4)Bad effects on developing countries (can no longer compete) 5)against international agreements (WTO and EU) BUT sometimes in the name of 'anti-dumping'
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What is the difference between devaluation and depreciation?
Devaluation= fixed exchange rate. Depreciation =floating exchange rate.
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How would depreciation/devaluation improve the current account deficit? + EVAL of why it might not / bad side effects
Exports become cheaper, imports more expensive. BUT EVAL= J-curve + ML condition +inflation +
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What is the Marshal-Lerner Condition?
If p.e.d. exports + p.e.d. imports > 1, then devaluation/depreciation of the exchange rate will improve the current account
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What is the J-curve effect?
Because demand tends to be v. inelastic in the short-run, the current account is likely to worsen before it improves (should be able to draw J-curve)
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Why might a deprecitation/devaluation be inflationary? (2 reasons)
1)cost-push inflation due to rise in price of imports 2)demand-pull due to increase in AD
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Why else might a fall in the exchange rate not help the current account?
Due to structural weaknesses/low growth of partners
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What are long-term cures to a current account deficit? Why?
Supply-side policies (would increase productivity + competitiveness)
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Give 3 examples of investment that could be undertaken for long-term cures (1st example on this card)
1)investment in human capital- improving management, E&T, healthcare BUT: -should these skills be developed by firms/gov? -what sort of training? -should we just encourage immigration instead?
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2)Investment in Physical Capital- replaces inefficient labour with efficient machines whilst productivity of remaining workers increases by allowing them to better perform manufacturing tasks BUT- increases structural unemployment
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3) investment in infrastructure- eases flow of workers, raw materials, and finished goods across the economy + stimulates both AD and LRAS BUT...-increases deficit, and time-lags mean gov. unlikely to spend on it (this eval can be applied to all)
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What else can be done other than investment?
1) tend companies towards more privately owned, small-medium sized companies 2)cut pay packages of top executives 3) develop trading units with emerging economies
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Why are publicly owned large companies less efficient?
They adopt a more short-termist approach, favouring cost cutting and short-term profit to be distributed as dividends
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Give real-world examples of more successful medium-small sized family owned companies
German and Japanese (such as Mittelstand)--> family run- managers and workers work together more loosely to look after long-term interest of the company. Invest more in training+capital equipment, improving competitiveness in the LR
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Why would cutting the pay-packages of top executives be effective?
Our lack of competitiveness sometimes put down to excessive executive pay ...Boardroom pay packages are up to 5x that of top Japanese or German managers, which crowds-out fund for investment
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How much of UK exports go to EU and US combined? (both been in recent recessions)
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What should UK look to developing its trading units with? Why?
Emerging economies such as MINT countries (Mexico, Indonesia, Nigeria and Turkey).- all going to see a rise in no. of ppl eligible to work relative to those not working. All (except nigeria) have advantageous geographical positions
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Give one last idea of what the UK could do...
...invest in Fracking so less dependent on imports for gas!
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Other cards in this set

Card 2


What 3 sections is the B of P split into?


1)Current Account 2)Financial Account 3)Capital Account

Card 3


What are the 4 components of the current account?


Preview of the front of card 3

Card 4


What is the financial account?


Preview of the front of card 4

Card 5


If we ran down reserve assets in B of E, what sign would it be on financial account?


Preview of the front of card 5
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