International Economics, 7e (Husted/Melvin)

Chapter 12 The Balance of Payments

Multiple-Choice Questions
1)

The current account includes

A)

the value of trade in merchandise.

B)

services.
C)

unilateral transfers.
D)

All of the above.

Answer:

2)

The U.S. Balance of Payments is constructed by

A)

the U.S. Department of Labor.

B)

the U.S. Department of Agriculture.

C)

the U.S. Department of Commerce.

D)

the Council of Economic Advisers to the President.

Answer:

C
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 3)

Debit entries on the Balance of Payments are the entries that would
A)

mean a loss of foreign exchange.

B)

bring foreign exchange into the country.

C)

indicate a surplus exists.

D)

exist at the bottom line after all accounts are totaled.

Answer:

4)

In the BOP, travel and tourism are included in the category of

A)

unilateral transfers.
B)

capital account.
C)

merchandise account.
D)

services account.
Answer:

5)

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Interest earned on foreign holdings of U.S. federal, state and local government debt are recorded in the
A)

services account.
B)

merchandise account.
C)

transfers account.
D)

capital account.
Answer:

6)

The balance of trade records

A)

trade in financial assets

B)

the current account plus long-term capital.

C)

the value of merchandise exports minus imports.

D)

short-term capital plus the basic balance.

Answer:

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 7)

A current account surplus implies that

A)

the country is a net lender with the rest of the world.

B)

the country is running a net capital account surplus.

C)

foreign investment in domestic securities is at very low levels.

D)

All of the above.

Answer:

8)

Security purchases in the United States by foreigners is

A)

a credit item in the current account.

B)

a debit item in the capital account.

C)

a credit item in the capital account.

D)

a debit item in the current account.

Answer:

9)

If we add the balance on long-term capital to the current account we get

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 A)

the official settlements balance.

B)

the balance of trade.

C)

the liquidity balance.

D)

the basic balance.

Answer:

10)

Current account deficits are offset by

A)

the liquidity balances.

B)

capital account surpluses.

C)

the basic balance.

D)

balance of trade surpluses.

Answer:

11)

With floating exchange rates, BOP equilibrium is restored by

A)

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trade restrictions.
B)

earnings from foreign investments.

C)

exchange rate changes.

D)

All of the above.

Answer:

12)

Merchandise exports minus imports equal the

A)

basic balance.
B)

liquidity balance.
C)

official settlements balance.

D)

balance of trade.
Answer:

13)

________ the largest international debtor in the world.

A)

Brazil
B)

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Mexico
C)

Italy
D)

The United States

Answer:

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 14)

Which of the following transactions is a debit in the current account?

A)

export of merchandise
B)

export of services
C)

gift to foreigners
D)

foreign bond purchase

Answer:

15)

The payment of a dividend by an American company to a foreign stockholder represents

A)

a debit in the U.S. capital account.

B)

a credit in the U.S. current account.

C)

a credit in the U.S. official reserve account.

D)

a debit in the U.S. current account.

Answer:

16)

The excess of total credits over total debits in the current and private capital accounts is called

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 A)

BOP deficit.
B)

BOP surplus.
C)

official settlements account surplus.

D)

official reserve assets.

Answer:

17)

________ indicates whether a country is a net borrower from or lender to the rest of the world.
A)

The basic balance

B)

The liquidity balance

C)

The capital account

D)

The current account

Answer:

18)

Direct investment and security purchases are included in

A)

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current account items.
B)

capital account items.

C)

basic balance account items.

D)

unilateral transfers.
Answer:

19)

________ is necessary to "balance" the BOP statement.

A)

Reserve inflow
B)

Statistical discrepancy
C)

Debit transaction
D)

Credit transaction
Answer:

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 20)

The current account is equal to

A)

S-I
B)

C+I+G+X
C)

I+X
D)

T-G
Answer:

True or False Questions

1)

The Balance of Payments always balances.

Answer:

True

Explanation:

Sum of the credits and debits on all accounts will always be equal.

2)

In the mid 1980s, the massive current account deficits were related to massive U.S. government budget
deficits.
Answer:

True

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 Explanation:

None Given

3)

The United States became a net international debtor in 1985 for the first time since World War I.
Answer:

True

Explanation:

None Given

4)

Because of the limited usefulness of both the basic balance and the liquidity balance accounts, these two
accounts are omitted in the official BOP table.
Answer:

True

Explanation:

None Given

5)

The United States finances current account deficits largely with dollars and, as a result, faces almost no
constraint on its ability to run deficits.
Answer:

True

Explanation:

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None Given

6)

With fixed exchange rates, central banks must finance trade deficits, allow a devaluation, or else use trade
restrictions to restore equilibrium.
Answer:

True

Explanation:

None Given

7)

It is possible for each nation to have BOP surpluses.

Answer:

False
Explanation:

None Given

8)

International free trade always hurts the nations that run deficits, and benefits the nations that run
surpluses.
Answer:

False
Explanation:

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None Given

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 9)

International Reserve assets are comprised of gold, foreign exchange, and IMF special drawing rights.
Answer:

True

Explanation:

None Given

10)

With flexible exchange rates, central banks do not have to finance deficits because BOP equilibrium is
restored by changes in exchange rates.
Answer:

True

Explanation:

None Given

11)

If domestic saving exceeds investment, there will be a current account surplus.

Answer:

True

Explanation:

None Given

12)

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National saving minus investment equals the current account.
Answer:

True

Explanation:

None Given

Essay Questions
1)

Define the official settlements balance. Is there any difference between the United States and other
countries in terms of what this balance measures? How does this affect the ability of the countries to run
current account deficits?
Answer:

For most countries it measures international reserve changes. For the United States, it records changes in
short-term U.S. liabilities held by foreign monetary agencies. This demand for dollar denominated short-
term debt by foreign central banks permits the United States to finance current account deficits largely
with dollars. Other countries must finance such deficits by selling foreign currency and, as a result, face a
greater constraint on their ability to run deficits as they eventually run out of international reserves. Such
a constraint does not exist for the United States.

2)

Answer the following questions briefly.

(a) Is it possible for each nation to have BOP surpluses? Explain.
(b) What is the "statistical anomaly" that imparts a bias to trade balances?
(c) Is it correct to argue that deficit countries are harmed while surplus countries benefit by
international free trade?
(d) How is the balance of payments linked to national saving and investment?
Answer:

(a) No. There is a globally balanced trade.

(b) Data collection. Exports are recorded when goods are shipped while, imports are recorded upon
receipt. Because there are always goods in transit from the exporter to importer, if we sum the BOT for
all countries we will realize a global trade surplus.
(c) No. If trade between nations is voluntary then it is difficult to make such an argument.
(d) If Y=C+I+G+X, then X=(Y-C-G)-I. (Y-C-G) is national saving so the current account (X) equals
national saving minus investment.

3)

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How are the following transactions entered into the U.S. balance of payments?
(a) The U.S. government sends $2,000 worth of food aid to Africa.
(b) A U.S. firm exports $10,000 worth of goods to the United Kingdom, payable in 3 months.
(c) A U.S. tourist in Amsterdam spends $200 for food and hotels.
Answer:

(a) The United States debits unilateral transfers for $2,000 and credits merchandise exports, also in its
current account, for $2,000.
(b) The United States credits merchandise in its current account for $10,000 and debits its short-term
capital account for $10,000.
(c) The United States debits the service category (travel) of its current account for $200, and credits its
capital account (an increase in foreign holdings of U.S. assets or claims on the United States) for $200.

4)

Explain how BOP disequilibrium is restored under

(a) flexible exchange rates.
(b) fixed exchange rates, after you define what a BOP disequilibrium means.
Answer:

(a) It is restored by exchange rate changes causing traded goods price changes.
(b) By allowing a devaluation or using trade restrictions or else central banks must finance deficits.

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