The balance of payments

The Balance of Payment• The balance of payments of a country is a systematic record of a country’s trade in goods, services, and financial assets between residents of that country and

The Balance of Payments

The Balance of Payment

• The balance of payments of a country is a systematic record of a country’s trade in

goods, services, and financial assets

between residents of that country and the rest of the world during a given period of time

– Private transactions (individuals and business firms)

– Official transactions (government transactions)

Economic Transaction

• Any transaction has two sides From the

point of view of home country, the two

sides are defined as:

– Credit: Are those transactions that will bring foreign exchange into the country

– Debit: Are those transactions that would mean a loss of foreign exchange

The Balance of Payment

• Table 12.1 provides an example of the

historic detailed balance of payments for the United States

• Simplified US balance of Payments for

2000

Simplified US Balance of Payments

Current account

• Includes the value of trade in merchandise, services, income, and unilateral transfers

• Figure 12.1 shows change in balance of

payments over time

• Current account excludes capital account transactions – purchases and sales of

financial assets

United States Current Account

Financing Current Account:

• Large current account deficit means large capital account surplus

• Important items included in the capital account:

– Direct Investment

– Security purchases

– Bank claims and liabilities

– U.S government assets abroad

– Foreign official assets in the United States

Capital Account

• One implication of capital account transaction

pertains to the net creditor or net debtor position of

National Savings, Investment and

National Savings, Investment and

Current Account

• Rearranging the above equation:

• Y-C-G=I+X=S

• Where S = national saving

– The above relationship indicates that national saving is equal to the sum of investment saving plus the current account balance

– Thus, current account must be equal to:

• X=S-I

National Savings, Investment and

Current Account

• The country where investment greater than saving, spending greater than income, has a current account deficit.

• The country where saving greater than

investment, income greater than spending, has a current account surplus

The World’s Largest Debtor

• September 10, 1985 US became a debtor nation

• In 1982 US reached its all-time high as a net

creditor ($147 billion)

• By 1985 US had massive current account deficits and corresponding capital account surpluses

• On September 1985, the U.S Commerce

department announced that the United States was a debtor nation for the first time since world war I

– The magnitude of current account deficit in 1985 and

1986 made the U.S the largest international debtor in the world with debt exceeding Mexico and Brazil.

The World’s Largest Debtor

• To consume more at home then is produced, the US must borrow from abroad

• US borrowed at high level

• Large reduction in US foreign lending

• US federal budget deficits made lending at home more attractive

The World’s Largest Debtor

• What can change this position?

• If dollar-denominated assets are no longer desired, dollar will tend to depreciate,

interest rates will fall

• Capital account surplus will equal to falling current account deficit

• US will become a net lender

Additional Summary Measures

• Balance-of-merchandise trade

• Official settlements balance is the value of the change in financial assets held by

foreign monetary agencies and official

reserve asset transactions

Transactions classification

1)US bank makes a loan of $1 million to a Romanian food

processor This loan is funded by creating $1 million

deposit for the Romanian firm in the US bank

2)US firm sells $1 million worth of wheat to the Romanian

firm The wheat is paid with the bank account created in

Balance of Payments Equilibrium

and Adjustment

• Economic implications of the balance of payments

• Global current account balance has summed to

deficit in recent years due to inaccurate

measurement of international financial transactions (service transactions)

• 2-country example of bilateral trade imbalances (A

is a wealthy creditor country and B is a poor

country that run trade surpluses with A

• Balance of payments equilibrium – exports equal imports or credits equal debits for a particular

account (current account or official settlements

account)

Balance of Payments Equilibrium

and Adjustment

• Current account equilibrium for a nation

would mean unchanging net creditor or

debtor position, no need for net financing

• Equilibrium on official settlements would mean no change in our financial assets held

by foreign monetary agencies and reserve assets

Balance of Payments Equilibrium

and Adjustment

• There is a disequilibrium in the balance of

payments, in official settlements part

• Deficit countries will experience reserve asset

losses and surplus countries – reserve

accumulation

• International reserve assets are composed of gold, IMF special drawing rights, and foreign exchange

• Lets consider change in international reserve

assets based on foreign exchange along

Balance of Payments Equilibrium

and Adjustment

• 1 British pound is worth 1.50 US dollars

• Supply-demand for foreign exchange market

• Demand for pounds comes from US demand for British goods or financial assets

• Supply of pounds comes from British buyers of

US goods or financial assets

• Upward sloping supply curve implies that as

pound appreiciates in value US products are

cheaper to Br Buyers, more pounds supplied to this market

Balance of Payments Equilibrium

• Fixed exchange rates –central banks set

exchange rates at desired levels

• Developing countries use direct controls on international trade to shift supply/demand curves