Chapter 11: The Balance of

Payments

The Balance of Payments

The balance of payments: records of a
countrys trade in goods, services, and
financial assets with the rest of the world.
_____ : what we receive
Any imports (
foreign exchange)
Debits recorded as a
value

Components of the BOP

Current Account
Capital Account
Financial Account

______ : what we give back in return

Any exports (
foreign exchange)
Credits recorded as a
value

The rule of double-entry bookkeeping

Current Account
Current Account (CA): the record of a countrys
income and expenditure (also called net
exports)
Merchandise trade: tangible commodities
Services: trade in the services of the factors of
production (includes tourism, royalties, transport
cost, insurance premiums)
Investment income: payment for the services of
physical capital (return on investments)
Unilateral transfers: foreign aid, gifts, retirement
pensions, interest paid to foreigners holding US.
Gov. debt

Current Account:
Credit (+) and Debit (-) Items
Credit Items (+)
Merchandise Export of goods.
Trade
Services
Export of services.
Investment
Income earned by US residents
Income
on their previous investments
abroad.
Unilateral
Transfer
TOTALS

Aid, gift, pension payments, etc.

received by US government or
residents from foreigners.
SUM OF CREDITS

Debit Items (-)

Import of goods.
Import of services.
Income paid to foreign residents on
their previous investments in the US.
Aid, gift, pension payments, etc. paid
to foreign governments or
individuals.
SUM OF DEBITS

CA balance = sum of credits + sum of debits

The Balance of Trade

The balance of ___________: (value of exports
of goods) - (value of imports of goods)
Balance of trade deficit: imp > exp
Balance of trade surplus: exp > imp

The balance of ___________: (value of exports

of services) - (value of imports of services).
The balance of _______________ : (Value of
exports of goods and services) - (value of
imports of goods and services).

How to Interpret Current Account

Balance?
Current Account _______
Credits < Debits
National income is
expenditure:
We have to

than national
to finance the deficit.

Current Account _______

Credits > Debits
Our income is
than our expenditure.
The economy effectively lends the

The CA indicates
Surplus a country is a net _______ to the
rest of the world
Deficit a country is a net ________ with the
rest of the world
B.O.P always in ______
Large U.S ________________ matched by
large ______________

Financial Account
Financial Account (FA): The record of a countrys
trade in financial assets
Direct investment
private financial transactions that result in the _________ of
10 % or more of a business firm

Capital flows
Security purchases: private-sector net purchases of equity (stock)
and debt securities
Bank claims and liabilities claims: loans, deposits abroad, claims
on affiliated foreign banks. Liabilities: deposits, certificates of
deposit, liabilities to affiliated foreign banks

Official transactions
changes in US official reserve assets, changes in foreign
official reserve assets in US.

Financial Account:
Credit (+) and Debit (-) Items
Credit Items (+)

Debit Items (-)

Foreign Direct
Investment

Sale of US businesses, real estate,

controlling shares in a firm, etc. to
foreigners.

Purchase of plants, real estate,

controlling shares in a firm, etc. abroad.

Financial flows

Sale of bonds and stocks to

foreigners, cash payments to
foreigners, deposits opened by
foreigners in US dollars, etc.

Purchase of bonds and stocks abroad,

cash payments from foreigners, deposits
opened by US residents in a foreign
currency, etc. INCLUDES CREDIT
EXTENDED
An increase in US official international
reserves (held overseas)

Official Reserve A decrease in US official

Transactions
international reserves (held
overseas)
TOTALS
SUM OF CREDITS

Capital Account

Transactions (U.S.)

Capital Account includes

Transactions involving debt forgiveness
Financial assets accompanying migrant workers as
they enter or leave the country.

Very small for the US.

SUM OF DEBITS

FA balance = sum of credits + sum of debits

Balance of Payments (BOP)

Credit (+) and Debit (-) Items
Credit Items (+)

Balance of Payments Basics

Debit Items (-)

Current Account

Assume BOP begins at zero.

Example 1: You buy a $30,000 Japanese car.

Merchandise
Services
Investment income

Balance of Payments Basics

Same transaction.
Extension 1: Japan uses the $30,000 to buy John
Deere tractors manufactured in the U.S.

Unilateral transfers
Current Account Balance

Financial /Capital
Account
Foreign direct investment
Financial flows
Official Reserve Transactions
Statistical Discrepancy
Financial Account Balance
TOTALS

TOTAL CREDITS

TOTAL DEBITS

Current account:
Capital account:
Sum =

BOP = sum of credits + sum of debits = ZERO

All transactions

National Saving, Investment, and the

Current Account
The national income accounting identity:

Y=
National income (GDP) equals consumption
spending (C), investment (I), government spending
(G), and the current account (X).
National saving:

S=YCG=
Hence, the current account must be equal to the net
saving:

X=SI

Current account =
Capital account =

National Saving, Investment,

and the Current Account
Recall CA = X and:
If

, then there will be a current account

, and a matching financial account

If

, then there will be a current account

, and a matching financial account

Saving: Private and Government

Recall
S=YCG=I+X
S=
Taxpayers pay T, governments receive T.
S=
National saving =
Recall X = S I, so anything impacting S, affects X
Twin Deficits:
Tendency for the two to occur at the same time.
Problem: ignores private saving: Y-T-C.

Other Causes of Persistent U.S. Deficits

Decrease in
cause of deficits.
1. U.S is worlds largest economy.

: major

2. Largest financial market no real alternative.

2. Deficits, Debt & Standard of Living

U.S:
debtor nation: net foreign
indebtedness $ trillion (end of
)
Nominal GDP (
): approx. $
trillion*
NFI: more than
% of GDP.*
CA deficit adds to debts: higher

CA Surplus and CA Deficit

Total value of global
= Total value of global
1. Can all countries have a current account
surplus?
2. Deficits, Debt & Standard of Living
3. Does a current account deficit matter?

Deficits, Debt & Standard of Living

Deficit paid through
of US securities to
foreigners
External debt: $
trillion.

1. Can all Countries have a surplus?

It is not possible for everyone to have a trade
surplus, so is a trade deficit bad?
Logic behind a trade surplus is
Some countries will always have
Mid 2014: nations current account surplus;
current account deficit

3. Does a Current Account Matter?

Some economists argue we need not worry
about a CAD.

Standard of living (per capita GDP)

U.S.

1. Increased Productivity
If financed from long term
inward

inflows

4. Helps Lower Inflation

A CAD provides an outlet for

2. Globalization
Globalization: easy to attract sufficient
to finance the

5. Reserve & Safe Haven Currency

US debt is denominated in

3. Currency Adjustment
Large deficit
consumer spending

. Slowdown in

6. Relocation of Jobs
Jobs relocated:

Reasons to worry about a CAD

Why is a persistent current account deficit
cause for concern?

3. Structural Weakness
A large,
CAD might be a sign of an
unbalanced economy:

1. Long Term Reliance on Foreign

Capital Flows
Reliance on capital flows, e.g. U.S & China.
China holds $

trillion of U.S. government debt.

4. Increased Foreign Liabilities

A CAD increases foreign liabilities, e.g.

2. Inability to Borrow
If investors lose confidence & stop buying US
debt,
Pressure on USD to

5. Long-Run Erosion of Assets

If long-term savings dont rise.

Interest payments/dividends are