November 2013

The Balance of PaymentsA record of the value of all the

transactions between the residents of one country with the residents of all other countries in the world over a given period of time.

The Balance of PaymentsCredits: inflows, payments received

from other countries.Debits: outflows, payments made to

other countries

The Balance of Payments

== Current AccountMeasure of the flow of funds from

trade in goods and services, plus other income flows

== Capital AccountMeasure of the flow of funds from

trade in non financial assets== Financial accountMeasure of the flow of funds from

trade in financial assets

Current AccountBalance of trade in goods = visible trade balance

Balance of trade in services = invisible balance = net services

Together these two items make up the balance of trade

Income (Wages, rents, interest and profits)

Current transfers: net unilateral transfers from abroad, payments made when no goods or services change hands (gifts, foreign aid, taxes and payments to the EU)

Balance of Trade

Trade in GoodsTrade in Goods

Manufactured GoodsEnergy ProductsSemi-finished productsRaw MaterialsConsumer and Capital Goods

Trade in ServicesTrade in Services

Banking and InsuranceConsultancyTourismTransport and ShippingEducation

ETC.

Current AccountImports represent an

Outflow of money

Exports represent an Inflow of money

Capital account and financial account

Assets = anything that can be owned and that has value (land, real estate, stocks, treasury bills, government, bonds, foreign currency, bank deposits)

Capital AccountSmall part of BoP- Capital tranfers:Net monetary movements due to debt forgiveness, transfer of goods

and financial assets by migrants entering or leaving the country, sale of fixed assets, gift taxes, inheritance taxes and death duties.

- Transaction in non-produced, non-financial assets

Net international sales and purchases of non-produced assets (land, rights to natural resources), and the net international transactions of intangible assets like patents, copyright, brand names and franchises.

Financial Account Direct investment: purchases of long term

assets, where the buyer is aiming to gain a lasting interest in a company in another economy (property, purchase of a business).

Portfolio investment: financial investments, such as stocks and bonds, saving accounts. Does not lead to a lasting interest. These are simply borrowing and lending.

Official reserves (or Reserve assets): reserves of gold and foreign currencies which all countries hold. It is movements into and out of this account that ensure that the BOP will always balance to zero. If there is a surplus on all the other accounts

combined, then the official reserve account total will increase.

If there is a deficit on all the other accounts, then the official reserve total will decrease.

Net Errors and OmissionsBalance of payments = Balance sheet

That means that IT MUST BALANCE!!!!Official reserves: in gold and in foreign currencies

make up the differenceWHY does it not always balance???

Mistakes, failure to record all items, generally due to a time delay can lead to a small discrepancy

Current Account Balance +Capital Account Balance +

Financial account balanceNet Errors and Ommisions +

Net Balance of Payment = 0

Balance of payments

Balance of payments

Balance of payments

Cumulative Current Account Balance 1980-2008 based on the IMF data

Cumulative Current Account Balance per capita 1980-2008 based on the IMF data

http://news.bbc.co.uk/2/hi/south_asia/7672462.stm Pakistan

http://www.bbc.co.uk/news/business-19644970 New

http://www.bbc.co.uk/news/world-16998244 Turkey

Current account deficit what does it mean?

Deficit on current account must be outweighed on the capital account and financial account HOW?-Foreign exchange reserves-Foreign investors-Borrowing from abroad

Consequences of persistent CA deficits1. Possible need for higher interest rates to attract foreign

investors.2. Risk of default if debt accumulated over long periods of

time. This leads to currency depreciation, difficulties of getting more loans and painful D-side policies.

3. Depreciating exchange rate, which might increase inflation.

4. Poor int’al credit ratings, making it more difficult to get more loans in the future. In that case higher interest rates might be needed.

5. Painful demand side policies to reduce imports.6. Fewer imports of needed capital goods.7. Cost of paying interest on loans.8. 6 and 7 imply lower economic growth in the future.

Correction of persistent CA deficits

1. Expenditure switching: away from imports and towards domestic goods

- Depreciation. Leads to higher import prices and risk of cost push inflation (capital goods and inputs become more expensive)

- Protectionism. Higher domestic prices of protected goods, lower consumption, inefficiency and global misallocation of resources, risk of retaliation.

2. Expenditure-reducing policies: influence X and M by reducing domestic expenditures through lower AD.

- Contractionary fiscal policies- Contractionary monetary policiesThe lower AD reduces inflation, which makes exports

more competitive.Disadvantages: risk of a recession, plus higher interest

rates may appreciate the currency offsetting the effects of the policies.

3. Supply-side policies to increase competitiveness. Market oriented policies intend to lower costs of

production and by shifting SRAS and LRAS to the right can result in lower inflation rates.

Interventionist policies can be used to promote industries that produce for export: support for training, education, R&D and industrial policies.

Current account surplus what does it mean?

Surplus on current account must be outweighed on the capital account and financial account HOW?-Foreign exchange reserves building up-Investing abroad-Appreciation of currencyOne country’s surplus is another country’s deficit possibility for protectionism

Possible problems:1.Low domestic consumption2.Insufficient domestic investment. Financial account deficit: funds are leaving the country risk of insufficient domestic investment less growth in the future.

3.Appreciation lower X and higher M lower AD.4.Reduced export competitiveness (3)