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43 Cards in this Set

  • Front
  • Back

Define balance of payments?

record of all inflows and outflows of money in and out of an economy

3 components?

current, financial and capital

4 catagories to credits on the current account and explain them with examples?

1. exports of goods - inflow

2. exports of services - inflow

3. income transfers - remitanes from Uk residents abroad back to the uk, interest earned abroad back to the uk and profits earned abroad by uk firms transferred to the uk

4. current transfers - gifts e.g. foreign aid

4 debits on the current account and explain with examples?

1. imports - outflow of currency

2. imports of services - outflow of currency

3.income transfers from foreign uk workers abroad and profits abroad and interest earned here transferred abroad

4. foreign aid to us

define FDI?

intevestment in at least 10% of foreign firms or purchase of physical assets e.g. offices

3 eg portfolio invesment?

stocks shares bonds

Define financial account?

records transactions between uk and row due to purchase of physcial and financial assets

4 credits on financial account?

1- FDI

2. portfolio incestment

3. financial derivatives

4. falls in foreign currency official reserves (means we are holding less of say USA assets)

4 debits on financial account?

1- fdi in other countries

2- porfolio investment

3- financial derivatives

4- rise in official foreign currency reserves (i.e. we hold more foreign assets)

explain changes in official foreign currency reserves?

a rise in foreign currency reserves mean an outflow of currency as we now hold more foreign assets so is a debit and vice versa

2 things in the capital account?

debt forgiveness + changes in assets due to migration

rule of BOP?

CA deficit = financial account surplus

explain why BOP must balance?

CA deficit means a fall in domestic foreign currency reserves which is a FA surplus therefore balance

Long term capital flows, what do they represent?

2 things included?

changes in decisions by investors to invest in assets in countries with a comparative advantage as they will gain a greater rate of return

includes portfolio and fdi

short term capital flow alternative name, word to describe them, e.g.?

hot money flows, speculative, currency transfers on forex markets

effect of CA deficit on ER explain?

implies a negative trade balance so more currency flowing abroad that here, so on diagram supply shifts outwards and causes a deprectiation - ceratus paribus should correct

4 reasons why CA and ER autocorrect may not occur?

1. 90% of currency transactions are not trade but speculative flows so probably won't autocorrect

2. ML condition

3. J curve

4. if caused by a lack of competitiveness(structuaral) probably won't be enough + just cause stagflation

3 costs of a current account deficit?

1. lower growth and higher unemployment

2. debt burdens may cause an economic crisis

3. exchange rate may depreciate and cause stagflation

1. explain lower growth and unemployment with diagram?

current account deficit implies a negative trade balance, so x-m is falling so fall in RGDP and rise in demand deficient unemployment

2. debt burdens explain?

also fiscal problems ?

CA deficit requires a FA surplus - easiest way to do this is for the government to issue debt (i.e. gov bonds + borrow from ROW), but if balloons out of proportion, fall in confidence to pay it back + currency and then financial and the economic crisis as people lose confidence and C and I fall - recision

crowding out and interest repayments

3. explain depreciation?

increase in supply of the currency so deprecation - in theory a good thing BUT no gurantee this will happen (ML, J , Speculation) and even so may not be enough to autocorrect CA deficit if caused by structural lack of competitiveness (UK) so import prices rise and stagflation may occur

3. depends on for CA deficit?

1. size - if very small percent of GDP not a problem to borrow but if more than 5% then a bad thing and may cause financial crisis

2. how financed - if financed by FDI + portfolio investment may reflect CA so not necessarily bad

3. type - cyclical (boom) vs sturtural

possible adv of CA deficit?

V strong AD and growth

2 costs of CA surplus?

DP inflation and a stagnating economy without enough demand (Japan)

list 4 gov policy to correct a CA deficit?

demand side (monetary or fiscal), protectionism, exchange rate devalue, ss policy

explain 2 ways Demnad side would work?

Major Disadv?

reduces demand for imports and reduces inflation (DP) making exports more price competitive


Protectionism, what type of policy?

BUT disdadv?

Expenditure switching,

ALL Free trade adv

Devaluation explain?

x increase and i fall

2 ways for SS policy?

would reduce lack of competitiveness problem caused by e.g. NMW or TU + would increase investment in R and D

2 evaluation points + diagram + explain?

1. ML condition - if sum of PED of imports and exports greater than one only then will deprecitation improve a current account deficit

2. J curve - in the SR will deteriorate CA as ML condition not satisfied (as PED Of imports and exports likely to be inelastic in ST as fixed contracts and lack info) but in LR will improve as can rengeoicate.

Define exchange rates?

price of a currency in terms of another or commodity

define a floating exchange rate + extra bit?

where the price of a currency is determined exclusivley by the forces of supply and demand with no government/ central intervention and changes on a minute by minute basis (spot rate)

what can you do in floating exchange rate? disadv? effect of cost of production?

trade in futures market and hedge against risk, but Op cost of time + expensive so raises cost of production

define a fixed ER ? what does this require?

government or central bank fixes price of currency against another currency/commodity

requires huge domestic and foreign currency reserves

define a managed exchange rate?

gov intervenes if outside a certain range

explain how fixed works with diagram when overvalued?

gov sells the pound increases the supply and fall in price of pound SEE NOTES

explain how fixed works if undervalued?

gov sells FC and buy up pound increasing demand SEE NOTES

what is an alternate way to fix ER? disadv?

by using interest rates - IR up ER up

BUT huge collateral damange

3 adv of floating ER? 4 eval

independent monetry policy

Autocorrection of CA deficit

protects for high world inflation

4 eval points from earlier

2 disadv of floating ER?

inflationaray spiral - high inflation X fall and m rise so may cause ER to depreciate and cause rising import costs

uncerainty for domestic firms who may have to hedge - expensive

3 adv of fixed ER?

1- less uncertainty - FDI rises and reduces cost of production as firms don't have to hedge and production costs fall

2- control inflation through revalue/ devalue

3- discipline domestic producers and cant rely of low ER so x inefficiency falls

4 disadv of fixed ER?

monetry policy may not be indapendant - collateral damage

costly to have foreign currency reserves

lack of info so difficult to set

don't benefit from autocorrection of current acocount

well done

well done