Unit: The Macroeconomy Topic: The Balance of Payments

Balance of Payments Definition: A country’s BOP is a record of all the economic transactions between residents of that country and residents in other countries

Balance of Payments Definition: A country’s BOP is a record of all the economic transactions between residents of that country and residents in other countries

First – we learned about changes in price level Order of Learning: First – we learned about changes in price level Second – Balance of Payments Third – Exchange Rates Why? Because a change in price level can affect the balance of payments Which in turn can affect the country’s exchange rate

Balance of Payments 3 Accounts – make up the BOP Current Account Capital Account Financial Account

BOP Accounts Terminology Credit Items Debit Items Money coming into the country Positive entries into the account Debit Items Money going out of the country Negative entries into the account

BOP Accounts Flash Quiz Q: For Chinas Balance of Payments. How would we classify the export of 1 Billion RMB worth of chopsticks to Japan?

BOP Accounts Flash Quiz Q: For Chinas Balance of Payments. How would we classify the export of 1 Billion RMB worth of chopsticks to Japan? A: It would be a credit entry. A positive entry in Chinas Balance of Payments.

1. Current Account 4 Parts Trade in Goods Trade in Services Income Current Transfers Any items, that are one of the four, will be entered as a credit or a debit in the current account.

1. Current Account Trade in Goods: Examples: trade of cars, tv’s, clothing Calculation: revenue from exports m Other Names: balance of trade, the visible balance, the merchandise balance

1. Current Account Trade in Services Examples: shipping, tourism, banking, insurance Calculation: revenue from the export of services less the spending on services imported from other countries Other Names: Invisible Services

1. Current Account Income Includes: Income in the form of Profits Interest and dividends earned on direct invesment abroad (Credit) E.g. Dividends paid on foreign shares If an American owns shares in Alibaba. Credit to USA Balance of Payment Foreign earnings on investment in the country (Debit) E.g. Dividend paid to a Chinese person who owns stock of Microsoft. Debit to USA Balance of Payment

1. Current Account Current Transfers Cover: Payments made and receipts received for which there is no exchange of goods and services. This includes: Payments to and receipts from international organisations and foreign aid Transfers by private individuals E.g. remittance of mone Mr Durham sends money from China to Canada is a Credit to the BOP of Canada

2. Capital Account Includes: Government debt forgiveness Money brought into and taken out of the country by migrants The sale and purchase of intellectual property (copyright, patent and trademark)

Balance of Payments Definition A record of all the transactions that take place between residents of a country and all other countries in the rest of the world. BOP has 3 Accounts Current Account Capital Account Financial Account

Balance of Payments Example – the UK Balance of Payments A credit (+) is a flow of money in to the UK A debit (-) is a flow money out of the UK Note Every Credit entry is matched by a Debit entry Example to follow

Balance of Payments Example – The UK Balance of Payments Records the flows of money between residents of the UK and non residents. Which direction did the money go How was it paid for

Balance of Payments If a UK resident exports goods abroad – this is a credit (+) Because Money flowed into the UK If the foreigner paid for the money with British Pounds – this is a debit (-) Because it is a decrease in liabilities abroad Meaning foreigners have less of the British currency

Balance of Payments Balancing Both sides of the transaction are recorded Both the credit and the debit The Balance of Payment should balance out Equal zero Incomplete Information Means it doesn’t always balance Net errors and omissions

Balance of Payments The Three Accounts – of Balance of Payment Current Account Capital Account Financial Account

Balance of Payments Current Account The current account consists of Trade in goods Trade in services Income Current transfers

Balance of Payments Current Account 1. Trade in Goods Items that can be touched, weighed or counted as they are traded Example – The import of cars from Germany to the UK is a debit to the current account of the UK Example – The export of shoes from the UK to Japan is a credit to the current account of the UK

Balance of Payments Current Account 2. Trade in Services The import and export of services Example – A UK resident buys a ticket on Air China. Its treated like an imported good – a debit to the UK’s current account Example – A Chinese company pays a fee to use a UK bank. Treated like an exported good – a credit to the UK’s current account.

Balance of Payments Current Account 3. Income Income from investments abroad Example – Profit (including dividends) paid on foreign shares help by a UK resident – is a credit in the current account Example – Interest paid to foreign holders of UK bank accounts – is a debit in current account

Balance of Payments Current Account 4. Current Transfers Made up of Central Government transfers and transfers by private individuals (such as gifts and cash) Example – A Transfer Payment from the UK to the EU – is a debit in the current account Example – A UK worker in China sends his salary home – is a credit in the current account

Relatively small part of most countries BOP Includes Balance of Payments Capital Account Relatively small part of most countries BOP Includes Government debt forgiveness Money brought in and out of the country by migrants Sale and purchase of intellectual property (trademarks, copyrights, patents)

The purchase or sale of non-financial assets Balance of Payments Financial Account Record transactions which involve the transfer of ownership of fixed assets; and The purchase or sale of non-financial assets Example – A UK company constructs a water purification plant abroad– is a debit in the current account Example – The UK government sells a building it owns in Beijing– is a credit in the current account

Balance of Payments Financial Account Records investment overseas by UK residents Debit (-) to UK Current Account Records the inward flow of investment funds by non-UK residents Credit (+) to the UK Current Account

Balance of Payments Look for Trends Economists look at BOP information over time Can find trends So Government can make the right policies Government policy is Chapter 7

Balance of Payments Review Which is not an argument a Balance of Payments Account The Total Account The Capital Account The Current Account The Financial Account

Balance of Payments Review If the country is China, a credit is A flow of money out of China A flow of money into China A negative entry in the current account Either a positive or negative entry in the current account

Balance of Payments Review Both sides of the BOP calculation do not always equal zero, usually because of The underground economy Protectionist policies Imports exceed exports Incomplete information

Balance of Payments Review The current account consists of Trade in Goods Trade in Services Current Transfers Income

Balance of Payments Review The export of shoes from the UK to Japan is a credit to the current account of the UK – What kind of entry is it? Trade in Goods Trade in Services Income Current Transfers

Balance of Payments Review A UK resident buys a ticket on Air China. It is entered in the UK current account as… A Debit to Trade in Goods A credit to Trade in Goods A debit to Trade in Services A credit to Trade in Services

Balance of Payments Review A Chinese resident earns interest on money he has in a UK. It is entered in the UK current account as A Debit to Trade in Income A Credit to Trade in Income A Debit to Trade in Current Transfers A Credit to Trade in Current Transfers

Balance of Payments Review German cars are imported into the UK. It is entered in the UK current account as… A Debit to Trade in Goods A credit to Trade in Goods A debit to Trade in Services A credit to Trade in Services

Balance of Payments Review A British person working in China sends his salary home to the UK every month. It is entered in the UK current account as A Debit to Trade in Income A Credit to Trade in Income A Debit to Trade in Current Transfers A Credit to Trade in Current Transfers

Balance of Payments Review The British government sells a building that it owns in Beijing. It is entered as… A Credit to the Current Account of the UK A Debit to the Current Account of the UK A Credit to the Capital Account of the UK A Debit to Current Transfers of the UK

Balance of Payments Disequilibria

Causes of Current Account Deficit 3 Main Causes A Growing Domestic Economy Declining Economic Activity of Trading Partners Structural Problems

Causes of Current Account Deficit Cause 1 – A Growing Domestic Economy If Domestic firms are increasing output, they may likely need more raw materials from abroad Means an increase in imports Not Considered a Problem Likely short-term and self correcting: imported raw materials may be used to make goods for export Foreign investment (credit in financial account) will offset some of the imports (debit in current account)

Causes of Current Account Deficit Cause 2 – Declining Economic Activity of Partners If economy of trade partners slows, then they will import less Result is decrease in trade in goods and services A current account deficit caused by a change in the economic (domestic or foreign) is called a “cyclical deficit.

Causes of Current Account Deficit Cause 2 – Declining Economic Activity of Partners Not Considered a Problem: If it is caused by a cyclical deficit Because it will be short term and self-corrects

Causes of Current Account Deficit Cause 2 – Declining Economic Activity of Partners Economic Cycle: "The business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP and other Macroeconomic variables To put it simply, the business cycle is defined as the real fluctuations in economic activity and gross domestic product (GDP) over a period of time.

Causes of Current Account Deficit Cause 2 – Declining Economic Activity of Partners Economic Cycle:

Causes of Current Account Deficit Cause 2 – Declining Economic Activity of Partners Economic Cycle: The fact that the economy experiences these ups-and-downs in activity should be no surprise. In fact, all modern industrial economies like that of the United States endure considerable swings in economic activity over time.

Causes of Current Account Deficit Cause 2 – Declining Economic Activity of Partners Economic Cycle: despite the name, the business cycle is not a regular, predictable, or repeating cycle. Though its phases can be defined, its timing is random and, to a large degree, unpredictable.

Causes of Current Account Deficit Cause 3 – Structural Problems x