4.6 Balance of Payments (DP IB Economics: HL): Flashcards
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Define the Balance of Payments (BoP).
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Define the Balance of Payments (BoP).
The Balance of Payments (BoP) is a record of all the financial transactions that occur between a country and the rest of the world.
How is money flowing into an account in the Balance of Payments recorded?
Money flowing into an account is recorded as a credit (+), while money flowing out is recorded as a debit (-).
True or False?
A deficit occurs in an account when more money flows into it than out of it.
False.
A deficit occurs when more money flows out of an account than into it; more money flowing in creates a surplus.
Define the current account.
The current account records the net income an economy gains from international transactions in goods, services and income transfers.
What is another name for trade in goods on the current account?
Trade in goods is also referred to as visible exports and imports.
On the current account, trade in services is also referred to as exports and imports.
On the current account, trade in services is also referred to as invisible exports and imports.
Define the capital account.
The capital account records small capital flows between countries, such as debt forgiveness and transactions in non-produced, non-financial assets.
Define the financial account.
The financial account records all transactions associated with changes of ownership of a country's foreign financial assets and liabilities.
Define foreign direct investment (FDI).
Foreign direct investment (FDI) is a flow of money to purchase a controlling interest (10% or more) in a foreign firm.
Which body controls a country's reserve assets?
A country's reserve assets, such as gold and foreign exchange, are controlled by the Central Bank.
True or False?
If a country has a current account deficit, it must have a surplus in its capital and financial account.
True.
The excess spending on imports is financed by money flowing in from the sale of assets, creating a capital and financial account surplus.
For the Balance of Payments to balance, the current account should offset the capital and financial account so that their sum equals .
For the Balance of Payments to balance, the current account should offset the capital and financial account so that their sum equals zero.
Define the current account.
The current account records the value of a country's trade in goods and services and transfers with the rest of the world.
What does the exchange rate determine?
The exchange rate determines the price of a country's currency in relation to other currencies.
How does a stronger exchange rate affect imports and exports?
A stronger exchange rate makes imports cheaper and exports more expensive.
True or False?
A weaker exchange rate makes a country's exports more expensive for foreign buyers.
False.
A weaker exchange rate makes imports more expensive and exports cheaper, potentially increasing export volumes.
When a country's currency appreciates, its exports become relatively more for foreign buyers.
When a country's currency appreciates, its exports become relatively more expensive for foreign buyers.
An outflow of domestic investment increases the of the country's currency, potentially leading to a depreciation.
Export volumes potentially increase, as exports become relatively cheaper for foreign buyers.
Define the financial account.
The financial account measures the inflows and outflows of financial assets, including foreign direct investment and portfolio investment.
How does an inflow of foreign investment affect the exchange rate?
An inflow of foreign investment increases the demand for the country's currency, potentially leading to an appreciation of the exchange rate.
An outflow of domestic investment increases the of the country's currency, potentially leading to a depreciation.
An outflow of domestic investment increases the supply of the country's currency, potentially leading to a depreciation.
True or False?
A stronger exchange rate makes a country more attractive as a destination for foreign investment.
False.
A stronger exchange rate makes foreign investments more expensive in the investor's home currency, potentially reducing the appeal of investing there.
How does a weaker exchange rate affect a country's attractiveness to foreign investors?
A weaker exchange rate makes a country's assets more affordable, potentially increasing its attractiveness to foreign investors.
Define a persistent current account deficit.
A persistent current account deficit is a situation where a country consistently spends more on imports than it earns from exports.
How can a persistent current account deficit affect a country's exchange rate?
It can put downward pressure on the currency (depreciation), as the economy is constantly supplying its currency onto world markets.
Why might a central bank raise interest rates in response to a persistent deficit?
Higher interest rates attract foreign and portfolio investment, raising demand for the currency and helping to stop it depreciating.
True or False?
A current account deficit and a budget deficit are the same thing.
False.
A budget deficit occurs when government spending exceeds government revenue, which is different from a current account deficit.
If a deficit is viewed as unsustainable, credit rating agencies may the country's creditworthiness, raising borrowing costs.
If a deficit is viewed as unsustainable, credit rating agencies may downgrade the country's creditworthiness, raising borrowing costs.
How can a chronic current account deficit affect national debt?
It can contribute to the accumulation of external debt, as financing is required to fund the deficit.
Define expenditure switching policies.
Expenditure switching policies aim to switch consumer spending away from imports and towards domestically produced goods and services, helping to improve a deficit.
Define expenditure reducing policies.
Expenditure reducing policies, such as deflationary fiscal policy, reduce discretionary income and therefore the demand for imported goods, improving a deficit.
Under floating exchange rates, how can a deficit self-correct if the government does nothing?
A higher level of imports depreciates the currency, making imports more expensive and exports cheaper, which improves the deficit over time.
What is a key risk of using expenditure switching (protectionist) policies?
They often lead to retaliation by trading partners, such as reverse tariffs or quotas, which can offset any improvement to the deficit.
True or False?
Supply-side policies are a quick way to correct a persistent current account deficit.
False.
Supply-side policies tend to be long-term policies, so their benefits may not be seen for some time.
Deflationary fiscal policy reduces discretionary income, which leads to a fall in the demand for goods.
Deflationary fiscal policy reduces discretionary income, which leads to a fall in the demand for imported goods.
Define the Marshall-Lerner condition.
The Marshall-Lerner condition states that a currency depreciation will only improve the current account balance if the combined price elasticities of demand for exports and imports are greater than one (elastic).
How does a currency depreciation affect the price of a country's exports and imports?
Depreciation makes exports cheaper for foreigners to buy and imports more expensive.
What is the term for a deliberate reduction in a currency's value under a fixed exchange rate system?
It is called a devaluation, whereas a fall in value under a floating system is called a depreciation.
True or False?
If the combined price elasticity of demand for exports and imports is inelastic, a depreciation will improve the current account balance.
False.
If the combined elasticity is less than one (inelastic), a depreciation will actually worsen the current account balance.
The revenue rule states that, to increase revenue, firms should lower prices for products that are price in demand.
The revenue rule states that, to increase revenue, firms should lower prices for products that are price elastic in demand.
Define the J-curve effect.
The J-curve effect describes how, following a currency depreciation, the trade balance initially worsens before it improves, due to a time lag.
Why is there a time lag before a depreciation improves the current account?
It takes time for firms and consumers to respond to the change in price and adjust their buying patterns.
On the J-curve, why does the trade deficit widen in the short run?
In the short run the sum of the PEDs for exports and imports is less than one (inelastic), so the Marshall-Lerner condition is not met.
On the J-curve, what leads the trade balance to move into surplus in the long run?
In the long run the Marshall-Lerner condition is met, so the trade balance improves and moves into surplus.
True or False?
A currency depreciation improves a country's trade balance immediately.
False.
With any currency depreciation or devaluation, the trade balance will initially worsen before it improves.
The J-curve shows that there is a between a currency depreciation and any subsequent improvement in the current account balance.
The J-curve shows that there is a time lag between a currency depreciation and any subsequent improvement in the current account balance.
Define a persistent current account surplus.
A persistent current account surplus occurs when a country consistently exports more goods and services than it imports.
Why does investment tend to rise during a persistent current account surplus?
Investment increases because exporting firms are making excellent profits.
Why does consumption tend to increase during a persistent current account surplus?
Higher profits raise domestic income, which leads to an increase in consumption.
How does a persistent current account surplus affect the exchange rate?
Higher exports mean foreigners demand more of the local currency, leading to currency appreciation.
True or False?
The appreciating exchange rate caused by a surplus makes the economy more desirable as a destination for foreign direct investment.
False.
Appreciating exchange rates make the economy less desirable as a destination for foreign direct investment.
With higher exports, foreigners demand more of the local currency to pay for their goods and services, leading to currency .
With higher exports, foreigners demand more of the local currency to pay for their goods and services, leading to currency appreciation.
What typically happens to unemployment during a persistent current account surplus?
Unemployment usually falls, as exporting industries require more workers.
What does the net effect of a persistent surplus on inflation depend on?
It depends on the extent to which domestic firms rely on imported raw materials in their production process.
How does a persistent current account surplus affect export competitiveness over time?
The associated appreciating exchange rate gradually erodes the nation's export competitiveness over time.
The extent to which export competitiveness is eroded depends on the price of demand for the country's exports.
The extent to which export competitiveness is eroded depends on the price elasticity of demand for the country's exports.
True or False?
If the PED for a country's exports is inelastic, currency appreciation erodes export competitiveness less than if demand were elastic.
True.
When PED for exports is inelastic, appreciation does not harm competitiveness as much as when the PED for exports is elastic.
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