1. Examine the Likely Effects of the Appreciation of the Real, Brazil’s Currency, on Its Balance of Payments Accounts. (10)

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Balance of payments is the difference in total value between payments into and out of a country over a given period. An appreciation means an increase in the value of a currency, and is worth more in terms of foreign currency. One impact of an appreciation on the current account is that exports are more expensive, so there is a fall in exports. Imports are cheaper so imports increase, creating a bigger deficit on the current account. This means that a strong real may lead to a worsening of the balance of trade – much depends on the value of price elasticity of demand for imports and exports. The impact of appreciation depends on the economy. As Brazil was not in a recession during the appreciation of the real, then the aggregate demand increased and helped reduce inflationary pressures and limit the growth rate. However, an appreciation of the real could also reduce inflation. This makes Brazil’s goods more competitive, leading to stronger exports in the long term, which could improve the current account. However, one effect is that the individuals with the highest GDP increase their FDI. This leads to an increase in net income for Brazil, through dividends and interest. This means that incomes of influential individuals are not being spent into the Brazilian economy, instead strengthening the currency of another currency. This could then lead to increased competitiveness between Brazil and other countries, as they begin to export products that could be cheaper or perhaps better quality. This causes the current account balance to decrease. Another reason is that if there were a reduction in FDI, the inward flows to the financial account of the Balance of Payments would decrease. With the reduction in financial account inward flows, there could be a reduction in the amount of money available to invest in the innovation of exports and therefore reduce the fall in
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