Balance of Payments

What is it?  A record of all financial dealings between economic agents of one country and the rest of the world.

 This can be split into two components.

 The Current Account  The Capital and Financial Accounts

 Flows of money into a country have a Positive (+) sign.  Flows of money out of a countray have a negative (-) sign.

The Current Account  Trade in goods  Visible or tangible goods such as shoes, copper, rice, cars and spaceships.  Export minus imports of goods = balance of trade

The Current Account  Trade in services  Invisible or intangiable services – banking, insurance, call centres and tourism.

 American tourist staying in a British hotel in London?  Japanese tourist flying an American airline to Prague?  A British tourist staying in a Slovakian hotel in Houston, Texas?

Current Account Transfers Current transfers include things such as profits, dividends and interest earned abroad. So, a British woman earns interest on her Swiss bank account – that is a current transfer. Dividends paid to a Swiss businessman on shares held in the New York stock exchnage. That’s a current transfer. With current transfer, no good or service changes hands.

 When we consider invisible goods, visible goods and current transfers we get the Current Account Balance of Payments.

The Capital and Financial Accounts  Foreign direct investment (FDI) refers to long-term capital investment, such as the purchase or construction of machinery, buildings, or whole manufacturing plants. If foreigners are investing in a country, that represents an inbound flow and counts as a surplus item on the capital account.

The Capital and Financial Accounts  Portfolio investment refers to the purchase of shares and bonds.  Other investment includes capital flows into bank accounts or provided as loans.

The Capital and Financial Accounts  Reserve account. The reserve account is operated by a nation's central bank to buy and sell foreign currencies.

Current Account Deficits and Surpluses  The balance of payments must always balance.  However there can be surpluses and deficits in certain parts of the account.

 This is the same as a household.  How can a household spend more than it makes?

Current Account Deficits and Surpluses  An economy can spend more than it earns if it borrows money from abroad.  It can have a current account deficit, where exports are less than imports by running a surplus on it`s capital account.

Causes of Changes in Current Account Balance  Change in Exchange Rate- A rise in the exchange rate may decrease exports and increase imports.

Causes of Changes in Current Account Balance  Many goods and services are specific to a certain country.  Exporters can gain an advantage by improving or distiguishing their products from others.

Causes of Changes in Current Account Balance  The importance of income and current transfers varies from country to country.  For some countries a huge amount of their income comes from their citizens earning incomes abroad and sending them home.

Current Deficits and Surpluses  Current account deficits are generally seen as bad.  Surpluses are generally seen as good.

Current Account Deficits and Surpluses  The size of the account deficit or surplus is important in determining it`s signifigance.

Large Sustained Current Account Deficits  These are bad because they can become unsustainable.  This has to be payed for.  The level of borrowings increases or the level of savings and investments held abroad decreases.

Large Current Account Deficits  There may come a point when lenders think that borrowers will default on their loans and stop lending them money.

Large Sustained Current Account Deficits  The level of the deficit needs to be compared against the rate of GDP growth.  If GDP Growth is larger than the deficit, there may not be a problem.

Large Current Account Surpluses  Governments could keep their exchange rates artificially low.  China  This increases exports but makes imports more expensive.

Large Current Account Surpluses  Strong exports help create jobs and boost economic growth.  This could build up a countries net wealth.

Large Current Account Surpluses  Disadvantages  Reduce what is available for consumption domestically.

Large Current Account Surpluses  Disadvantages  Can cause friction between countries.  Countries can only reduce current account deficits if other countries reduce current account surpluses.

Governement  The current account deficit is not paid for by the government.  Government borrowing is not the same as a current account deficit.  Generally a deficit is caused by transactions involving individuals and firms.