1. Gravurev.ppt Balance of Payments (BOP) uDefinition of BOP: Record of transactions between residents of one country & rest of the world uFunctions of BOP: Helps forecast market potential of a country Helps to understand the currency fluctuation of a country It is a poor description of National Economy Useful in measuring economic performance if there is FER $ was indexed at 100 at 1970: If index is greater than 100,$ gain Vs other countries currencies.  Accounts of BOP: Trade Balance : Net balance in merchandise traded Current Account: Trade account+earning & expe on services Performed service: travel, shipping, banking, insurance, etc Debt service: interest, dividend received or paid abroad. MENU

2. Gravurev.ppt Balance of Payments (BOP) Cont.. Basic Balance: Current account+long term capital (such as direct investment) Overall Balance: basic Balance+short term capital +Error & Omission Unilateral Transfer: no corresponding flow of G&S-non military goods, grants, foreign aids, donation, inheritance Capital account: record of investment & payments  Macro Modeling of BOP:  Aggregates Income : Y=C+S, Where,  C=Agg Consumption & S=Agg Saving  Aggregate Expenditure: E=C+Id, where Id=Domestic investment  Y-E=S-Id If Y is greater than E, S is greater than Id MENU

3. Gravurev.ppt Balance of Payments (BOP) Cont..  Coping with Current account deficit (CAD):  Relationship between CAD & currency depreciation  According to General Equilibrium View : not a simple one  1976-1980: $ depreciate, CAD decreased  1980-1985 $ appreciate, CAD increased  Impose high tariffs & quotas:  Since S-Id=X-M, (unless S & Id changes), if M decline, X must decline : less import means less demand for foreign currency, less supply of domestic currency, and an increase in value of domestic goods, which mean less export.  End Foreign ownership of domestic assets  No capital account surplus means interest rate will increase & investment & income will decline  Stimulate savings: If S is greater than Id, we will have capital outflow, causing deficit to decrease in both Government budget & Current Account. MENU

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