BALANCE OF PAYMENTS

BALANCE OF PAYMENTSA country’s balance of payments accounts

keep track of both its payments to and its receipts from foreigners.

Any transaction resulting in a payment to foreigners is entered in the balance of payments accounts as a debit and is given a negative (—) sign.

Any transaction resulting in a receipt from foreigners is entered as a credit and is given a positive (+) sign.

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Balance of Payments Accounting

The Balance of Payments is the statistical record of a country’s international transactions over a certain period of time presented in the form of double-entry bookkeeping.

N.B. when we say “a country’s balance of payments” we are referring to the transactions of its citizens and government.

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The balance of payments accounts are those that record all transactions between the residents of a country and residents of all foreign nations.

They are composed of the following:

The Current AccountThe Capital AccountThe Official Reserves AccountStatistical Discrepancy

Balance of Payments Accounts

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The Current Account

Includes all imports and exports of goods and services.

Includes unilateral transfers of foreign aid.

If the debits exceed the credits, then a country is running a trade deficit.

If the credits exceed the debits, then a country is running a trade surplus.

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The Capital Account

The capital account measures the difference between sales of assets to foreigners and purchases of foreign assets.

The capital account is composed of Foreign Direct Investment (FDI), portfolio investments and other investments.

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Official Reserves Acccount

• Records level of official reserves

• Four types of assets• – Gold• – Convertible currencies• – SDRs• – Reserve positions at the IMF

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Statistical Discrepancy

There’s going to be some omissions and misrecorded transactions—so we use a “plug” figure to get things to balance.

BALANCE OF PAYMENTS:CURRENT ACCOUNT

The balance of payments accounts divide exports and imports into three categories:Merchandise trade

Exports or imports of goods.

ServicesPayments for legal assistance, tourists’ expenditures,

and shipping fees.

IncomeInternational interest and dividend payments and the

earnings of domestically owned firms operating abroad.

It also includes unilateral current transfers (like gifts and foreign aids).

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BALANCE-OF-PAYMENT

. Capital Accounta. Function: records public and private investment and lending.b. Inflows = creditsc. Outflows = debitsd. Transactions classified as

1.) portfolio2.) direct3.) short term

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BALANCE-OF-PAYMENT

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

BALANCE OF PAYMENTS

Simple rule of double-entry book keeping:“Every international transaction automatically

enters the balance of payments twice, once as a credit and once as a debit.”

It holds true as every transaction has two sides:If you buy something from foreigner, you must

pay him/her in someway.

BALANCE OF PAYMENTS:STATISTICAL DISCREPANCY

Data associated with a given transaction may come from different sources that differ in coverage, accuracy, and timing.

This makes the balance of payments accounts seldom balance in practice.

Account keepers force the two sides to balance by adding to the accounts a statistical discrepancy.

BALANCE OF PAYMENTS

Official Reserve TransactionsCentral bank

The institution responsible for managing the supply of money.

Official international reservesForeign assets held by central banks as a

cushion against national economic misfortune.

Official foreign exchange interventionCentral banks often buy or sell international

reserves in private asset markets to affect macroeconomic conditions in their economies.

EXCHANGE RATES AND TRADE

When individuals, businesses and governments in one country want to trade, borrow or lend in another country, they must convert their currency into the other country currency for the transaction.

Exchange rates are important because they enable us to translate different counties’ prices into comparable terms.

Exchange rates are determined in the same way as other asset prices i.e. supply and demand.

EXCHANGE RATES

Two types of changes in exchange rates:Depreciation of home country’s currency

A rise in the home currency prices of a foreign currency.

It makes home goods cheaper for foreigners and foreign goods more expensive for domestic residents.

Appreciation of home country’s currencyA fall in the home price of a foreign currency.It makes home goods more expensive for

foreigners and foreign goods cheaper for domestic residents.