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The Balance-of-Payments Accounts

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 19Chapter 19

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Learning Objectives

• Explain what is meant by a country’s “balance-of-payments” statement and how it is constructed.

• Analyze the difference between alternative accounting balances within the balance-of-payments.

• Define the international investment position of a country.

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Balance-of-Payments

• Balance of payments accounts are a way of keeping track of all economic transactions between the home country and the rest of the world over a specific time period (usually one year).

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Recent Growth of Trade and Capital Movements

• The value of trade in goods and services has increased from $582 billion in 1973 to $15.8 trillion in 2008.

• International transactions of the monetary sort have also grown very rapidly over the last few decades.

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Credit and Debits in Balance-of-Payments Accounting

• Credit items reflect transactions that give rise to payments flowing into the home country.– e.g., exports, foreign investment inflows,

interest payments on earlier investments

• Debit items reflect transactions that give rise to payments flowing out of the home country.– e.g., imports, foreign investment outflows,

interest payments to foreigners

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Credit and Debits in Balance-of-Payments Accounting

• The IMF groups items into four categories– Category I: Current account,– Category II: Direct investment and other long-

term financial flows,– Category III: Short-term nonofficial financial

flows, and– Category IV: Changes in reserve assets of

official monetary authorities (central banks).

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Credit and Debits in Balance-of-Payments Accounting

• Category I: Current account– Credit items include exports of goods and

services, interest and dividends from investments abroad, wages earned abroad, and gifts from abroad.

– Debit items include imports of goods and services, interest and dividends paid to investors abroad, wages paid to foreigners, and gifts sent abroad.

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Credit and Debits in Balance-of-Payments Accounting

• Category II: Direct investment and other long-term financial flows– Credit entries: anything that causes a net

increase in the holdings of assets in the home country by the foreign country.

– Debit entries: anything that causes a net increase in the holdings of assets in a foreign country by the home country.

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Credit and Debits in Balance-of-Payments Accounting

• Category III: Short-term nonofficial financial flows– These are mainly private flows, with

maturities under one year.– Credit items: any increase in foreign holdings

of such assets in the home country.– Debit items: any increase in home country

holdings of such assets in the foreign country.

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Credit and Debits in Balance-of-Payments Accounting

• Category IV: Changes in reserve assets of official monetary authorities (central banks)– Credit items: whenever the foreign country

central bank acquires home country assets (such as bank accounts).

– Debit items: whenever the home country central bank acquires foreign country assets.

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Sample Entries in the Balance-of-Payments Accounts

• In general, balance-of-payments accounting relies on double-entry bookkeeping.

• This means that any transaction must be added as a credit and a debit.

• This implies that the sum of all credits must equal the sum of all debits, and the total BOP is always in balance.

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Sample Entries in the Balance-of-Payments Accounts

#1: Exporters in the U.S. send $6,000 of goods to Canada, receiving a short-term bank deposit of $6,000 from Canada.– Credit: Category I: Export of goods +

$6,000– Debit: Category III: Increase in short-term

private assets abroad -$6,000

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Sample Entries in the Balance-of-Payments Accounts

#2: Consumers in the U.S. buy $10,000 of goods from Canada, paying with a short-term bank deposit of $10,000.– Debit: Category I: Imports of goods -

$10,000– Credit: Category III: Increase in foreign

short-term assets in the U.S. +$10,000

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Sample Entries in the Balance-of-Payments Accounts

#3: U.S. residents send $5,000 to Mexico as gifts.– Credit: Category I: Exports of +$5,000– Debit: Category I: unilateral transfer of -

$5,000

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Sample Entries in the Balance-of-Payments Accounts

#4: An American firm provides $2,000 of shipping services to a Canadian company, which pays by transferring money into its U.S. account.– Credit: Category I: export of services +

$2,000– Debit: Category III: Decrease in short-term

private assets in the U.S.: -$2,000

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Sample Entries in the Balance-of-Payments Accounts

#5: A Canadian company sends $8,000 in dividends to bank accounts of American stockholders.– Credit: Category I: investment receipts

from abroad +$8,000– Debit: Category III: Decrease in short-term

private assets in the U.S.: -$8,000

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Sample Entries in the Balance-of-Payments Accounts

#6: An American buys a long-term bond from a Mexican company for $2,000; transfers payment from her U.S. bank account.– Debit: Category II: increase in long-term

asset abroad -$2,000– Credit: Category III: Increase in short-term

private assets in the U.S.: +$2,000

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Sample Entries in the Balance-of-Payments Accounts

#7: Canadian banks wish to reduce holdings of dollars in U.S. banks by selling $800 to the Federal Reserve.– Debit: Category III: Decrease in short-term

private assets in the U.S.: -$800– Credit: Category IV: Increase in foreign

short-term official assets in the U.S.: +$800

Assembling a BOP Summary Statement

Debits Credits

#1 Increase in short-term private assets abroad

-$6,000 Exports of goods +$6,000

#2 Imports of goods -$10,000 Increase in foreign short-term private assets in US

+$10,000

#3 Unilateral transfers -$5,000 Exports of goods +$5,000

#4 Decrease in foreign short-term assets in U.S

-$2,000 Exports of services +$2,000

#5 Decrease in foreign short-term assets in U.S

-$8,000 Investment income from abroad

+$8,000

#6 Increase in long-term assets abroad

-$2,000 Increase in foreign short-term private assets in US

+$2,000

#7 Decrease in short-term private assets in the U.S.:

-$800 Increase in foreign short-term official assets

+$800

-$33,800 +$33,80019-19

BOP SummaryCategory

I Exports of Goods +$11,000

Imports of goods -$10,000

Merchandise trade balance +$1,000

Exports of services +$2,000

Imports of services -$0

Balance of goods and services +$3,000

Factor income receipts from abroad +$8,000

Factor income payments abroad $0

Balance on goods, services, and investment income +$11,000

Unilateral transfers received +$0

Unilateral transfers made -$5,000

CURRENT ACCOUNT BALANCE +$6,000

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Current Account BalanceReflects sources and uses of national income

Y = C + I + G + (X – M)X: not only exports but all credit items in the current accountM: Not only imports but all debit items in the current accountY – (C + I + G) = (X – M)If (X – M) < 0 → Country is spending more than its incomeIf (X – M) > 0 → Country is spending less than its income

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Current Account Balance

Y = C + S + TC + I + G + (X – M) = C + S + T(X – M) = S + (T – G) – IIf (X – M) < 0 →country is saving less than it invests If (X – M) > 0 →country is saving more than it invests

BOP Summary (cont’d)Category

II Net increase in foreign long-term assets in U.S. +$0

Net increase in long-term assets abroad -$2,000

BASIC BALANCE +$4,000

III Net increase in foreign short-term private assets in U.S. +$1,200

Net increase in short-term private assets abroad -$6,000

OFFICIAL RESERVE TRANSACTIONS BALANCE -$800

IV Net increase in foreign short-term official assets in U.S. +$800

Net increase in official assets abroad -$0

TOTAL $0

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Financial Account Balance

Category II -$2,000 Category III -$4,800 Category IV + $800 Financial Account Balance -$6,000

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Different Measures of Balance

• Merchandise trade balance• Balance on goods and services• Balance on goods, services and factor income• Current account balance• Balance on currenct account and long term

assets• Official reserve transactions balance• Financial account balance

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Statistical Discrepancy

• The current account balance may not exactly equal the financial account balance due to incomplete or imperfect data, illegal activities, and mismatches on the timing of data collection.

• To account for these, a category called “statistical discrepancy” is included in the BOP.

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Balance of Payments - Monthly Analytic Presentation (2011-2012 December)