A-Level Economics: The Balance of Payments and Correcting Imbalances

Most students can list the parts of the current account. A level questions go further: how is a deficit financed, does it matter, and what can a government do about it without damaging its other objectives? This material trains the balance of payments beyond the current account, together with the policies used to correct imbalances.

It starts with the structure of the accounts. You distinguish the current, capital and financial accounts, classify flows such as a foreign firm building a factory (foreign direct investment) and a pension fund buying government bonds (portfolio investment), and calculate a current account balance of −£95 billion from its four parts and express it as 3.8% of GDP. The balance of payments identity then explains why a current account deficit must be matched by net financial inflows, and why the type of inflow matters: long-term FDI is far more stable than short-term borrowing and hot money, which can reverse suddenly and force a sharp currency fall.

The policy section compares expenditure-reducing policies, which cut total spending and so imports, at the cost of growth and jobs, with expenditure-switching policies such as devaluation, tariffs and export subsidies, which change relative prices, and with supply-side policies that raise competitiveness in the long run. You calculate how unit labour costs change when wages rise by 5% and productivity by 2%, and use relative unit labour costs, relative export prices and the real exchange rate as measures of international competitiveness. A question on a managed float shows how a central bank can slow a currency's fall by buying it with reserves and raising interest rates, and why reserves limit how long it can do so.

Finally, the material looks at the world as a whole: current account balances across countries must sum to zero, so if many deficit countries cut spending at once while surplus countries do nothing, world demand falls. It complements the category's materials on macroeconomic indicators and on trade and exchange rates, which cover the current account components, the Marshall–Lerner condition and the J-curve, rather than repeating them.

The material offers a 12-question quiz with explanations, a flashcard deck of key terms, a printable written sheet of eight questions with model answers (including balance of payments and unit labour cost calculations), and an oral exam in which an examiner questions you on imbalances and policy one question at a time. For example, AQA covers this in its balance of payments and exchange rate systems sections, and Pearson Edexcel in Theme 4 on the balance of payments and international competitiveness.

• Distinguish the current, capital and financial accounts and classify FDI and portfolio flows
• Calculate a current account balance and express it as a percentage of GDP
• Explain how a current account deficit is financed and why the type of financing matters
• Compare expenditure-reducing, expenditure-switching and supply-side policies for correcting imbalances
• Measure international competitiveness using unit labour costs and the real exchange rate
• Analyse central bank intervention in a managed float and the global implications of imbalances

Practice material written by Zestly, based on the DfE GCE A level economics subject content (2014), 'The global context' and 'The application of policy instruments' (exchange-rate policy), with examples drawn from the AQA (the balance of payments; exchange rate systems) and Pearson Edexcel (Theme 4, balance of payments; international competitiveness) specifications. All figures in the questions are invented for practice.