Chapter 16: Payments among Nations

Accounting Principles The balance of payments (BOP) is an accounting of a country's international transactions for a particular time period Double-entry accounting. Each transaction has two items An item that would cause funds or money to flow into a country is a credit, recorded as positive value An item that would cause funds or money to flow out is a debit, recorded as a negative value For a category of items, a balance that is positive is a surplus, one that is negative is a deficit 2016 McGraw-Hill Education. All Rights Reserved. 2

Current Account Exports and imports of goods (merchandise) are all flows of raw materials and manufactured goods out of and into the country Exports and imports of services include tourism, transportation, insurance, education, telecommunications, and professional services Income flows are mainly receipts and payments (interest, dividends, other claims on profits) to holders of foreign financial assets Unilateral transfers are gifts (like governmental foreign aid and migrant remittances) that the country receives and that the country makes 2016 McGraw-Hill Education. All Rights Reserved. 4

Current Account Current account balance is the net value of flows of goods, services, income, and unilateral transfers Goods and services balance is somewhat narrower, the number obtained by adding up exports and imports of goods and services The balance on goods and services measures the country s net exports (trade balance) 2016 McGraw-Hill Education. All Rights Reserved. 5

Financial Account Financial account balance is the net value of flows of financial assets and similar claims Credits: funds are flowing into the country (positive items) Foreign resident increasing her holding of a U.S. financial asset (a stock, a bond, an IOU from a loan) U.S. resident decreasing her holding of a foreign asset (a stock, a bond, an IOU from a loan) Debits: funds are flowing out of the country (negative items) Foreign resident decreasing his holding of a U.S. financial asset (a stock, a bond, an IOU from a loan) U.S. resident increasing her holding of a foreign financial asset (a stock, a bond, an IOU from a loan) 2016 McGraw-Hill Education. All Rights Reserved. 6

Balance of Payments Official international reserves are money-like assets that are held by governments and that are recognized by governments as fully acceptable for payments between them Gold was used in the late 19 th and early 20 th centuries Foreign exchange assets are used now Statistical discrepancy it is the net result of errors and omissions on both the credit and debit sides For the U.S. much of the discrepancy is undermeasurement of private capital flows 2016 McGraw-Hill Education. All Rights Reserved. 7

The Macro Meaning of the Current Account Balance The country s current account balance must equal net foreign investment, the increase in the country s foreign financial assets minus the increase in the country s foreign financial liabilities If the country has a current account surplus, then its foreign assets are growing faster than its foreign liabilities. The country s net foreign investment is positive it is acting as a net lender to the rest of the world If the country has a current account deficit, then its foreign liabilities are growing faster than its foreign assets. The country s net foreign investment is negative it is acting as a net borrower from the rest of the world 2016 McGraw-Hill Education. All Rights Reserved. 9

The Macro Meaning of the Current Account Balance 1. CA = I f where I f = net foreign investment 2. CA = S - I d where S = national saving, I d = domestic real investment 3. CA = Y E where Y = domestic production (GDP), E = domestic expenditures = C + I d + G According to 2, when a nation has current account surplus (CA > 0), then S > I d According to 3, when a nation has current account surplus (CA > 0), then Y > E 2016 McGraw-Hill Education. All Rights Reserved. 10

The Macro Meaning of the Overall Balance The overall balance should indicate whether a country s balance of payments has achieved an overall pattern that is sustainable over time. No single indicator represents overall balance perfectly. Useful indicator: The official settlement balance (B) measures the sum of current account balance (CA) plus the (nonofficial) financial account balance (FA) [plus any statistical discrepancy]: B = CA + FA 2016 McGraw-Hill Education. All Rights Reserved. 15

The Macro Meaning of the Overall Balance Because all items in the BOP must sum to zero, any imbalance in the official settlement balance must be financed through official reserves flows (OR): B + OR = 0 B is in surplus: Must equal an accumulation of official reserve assets by the country or a decrease in foreign official reserve holdings of the country s assets B is in deficit: Must equal a decrease in the country s holdings of official reserves, or an accumulation foreign official reserve holdings of the country s assets Most of the transactions by the counties monetary authorities that result in changes in official reserve holdings are official intervention in foreign exchange markets. 2016 McGraw-Hill Education. All Rights Reserved. 16

The International Investment Position International investment position is a statement of the stocks of a nation s international assets and foreign liabilities at a point in time, usually the end of a year. 2016 McGraw-Hill Education. All Rights Reserved. 17