Mukul

Bhatia

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BALANCE-OF-PAYMENT CATEGORIES

II. THE INTERNATIONAL FLOW OF GOODS, SERVICES,AND CAPITAL III. COPING WITH CURRENT ACCOUNT DEFICITS
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 Balance

of payments (BoP) is a record of all monetary transactions of a country with rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers.
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 When

all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries.
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 Under

a fixed exchange rate system, the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country's currency and other currencies
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A.

THE BALANCE OF PAYMENTS (B-O-P)

1. PURPOSE: Measures all financial and economic transactions over a specified period of time.
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2. Double-entry bookkeeping a. Currency inflows = credits earn foreign exchange b. Currency outflows = debits expend foreign exchange

Three Major Accounts: a. Current b. Capital c. Official Reserves 4. Current Account- records net flow of goods, services, and unilateral transfers.

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5. Capital Account a. Function: records public and private investment and lending. b. Inflows = credits c. Outflows = debits

5. Capital Account (cont) d. Transactions classified as 1.) portfolio 2.) direct 3.) short term

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6. Official Reserves Account a. Function: 1.) measures changes in international reserves owned by central banks. 2.) reflects surplus/deficit of a.) current account b.) capital account

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6. Official Reserves Account (cont)

b. Reserves consist of 1.) gold 2.) convertible securities

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7. Net Effects: a. Sum of all transactions must be zero:

1.) current account 2.) capital account 3.) official reserves

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8. The Balance-of-payment measures a. Some Definitions: 1.) Basic Balance

a.) consists of current account and long-term capital flows.

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1.) Basic Balance (cont)

b.) emphasizes long-term trends.

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1.) Basic Balance (cont) c.) excludes short-term capital flows that heavily depend on temporary factors.

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2.) Net Liquidity Balance: measures the change in private domestic borrowing or lending require to keep payments equal without adjusting official reserves.

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3.)

Official Reserve Transactions Balance

- measures adjustments needed by official reserves.

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II.

LINKS FROM INTERNATIONAL TO DOMESTIC FLOWS A. Global Linkagesset of basic macroeconomic identities which link: domestic spending and production to current and capital accounts

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B. Domestic Savings and Investment and the Capital Account 1. National Income Accounting a. National Income (NI) is either spent (C) or saved (S)
NI = C + S

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b. National spending (NS) is divided into personal spending (C) and investment (I) NS = C + I

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c.

Subtracting NI - NS = S - I

If NI >NS, S > I which implies that surplus capital spent overseas.

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d. In a freely-floating system, excess saving = the capital account balance e. Implications:

1. A nation which produces more than it spends will save more than it invests domestically with a net capital outflow producing a capital account deficit.

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2. A nation which spends more than it produces has a net capital inflow producing a capital account surplus. 3. A healthy economy will tend to run a current account deficit.

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C.

THE LINK BETWEEN THE CURRENT AND CAPITAL ACCOUNTS 1. Beginning identity NI - NS = X - M where X = exports M = imports X-M=current account balance (CA)

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2. 3. (NFI)

Combining S - I = X - M If S - I = Net Foreign Investment NFI = X - M

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4. Implications: a. If CA is in surplus, the nation must be a net exporter of capital. b. If CA is a deficit, the nation is a major capital importer. c. When NS > NI, the excess must be acquired through foreign trade.

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d. Solutions for Improving CA deficits: 1.) 2.) Raise national income (output) relative to domestic investment (I). Increase (S) relative to domestic investment (I).

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D. GOVERNMENT BUDGETS AND CURRENT ACCOUNT DEFICITS 1. CURRENT ACCOUNT BALANCE

CA = Saving Surplus - Govt budget deficit

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2. CA Deficit means

the nation is not saving enough to finance (I) and the deficit. 3. CA Surplus means the nation is saving more than needed to finance its (I) and deficit.

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I.

POSSIBLE SOLUTIONS UNLIKELY TO WORK: A. Currency Depreciation

B.

Protectionism

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II.CURRENCY DEPRECIATION A. U.S. Experience: Does not improve the trade deficit.

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B. Depreciations are ineffective because 1. 2. It takes time to affect trade. J-Curve Effect

states that a decline in currency value will initially worsen the deficit before improvement.

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J Curve Effect-Following a currency

depreciation, the trade balance may at first deteriorate before it improves.

Change in the Trade balance

Time

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III.

PROTECTIONISM A. Trade Barriers used: 1. Tariffs 2. Quotas B. Results:

Most likely will reduce both X and M.

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C. FOREIGN OWNERSHIP one protectionist solution would place limits on or eliminate foreign ownership leading to capital inflows.

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D.

STIMULATE NATIONAL SAVING change the tax regulations and rates.

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III. SUMMARY: CURRENT-ACCOUNT DEFICITS - neither bad nor good inherently 1.Since one countrys exports are anothers imports, it is not possible for all to run a surplus

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2. Deficits may be a solution to the problem of different national propensities to save and invest.

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 Thank

You

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