The Balance of Payments. © 2002 by Stefano Mazzotta 1 Learning Outcomes 1. Definition of the...

The Balance of Payments

© 2002 by Stefano Mazzotta

2

Learning Outcomes

1. Definition of the balance of payments (BOP) and its accounts

2. Some macroeconomic relations

3. The link between BOP and exchange rates

4. Comments on current account deficit

1. Definition of the Balance of Payments and its

Accounts


4

The definition of BOP

• It is a statistical statement of all economic and financial transactions between the home country and the rest of the world during a certain time period.

• The net of all transactions affects the country’s international monetary reserves.


5What are the types of

transactions?

• Exports of goods and services

• Imports of goods and services

• Gifts and other “one-sided” payments

• Income flows

• Capital flows


6

The importance of the BOP

• Helps forecast a country’s economic potential, especially in the short run, and its competitiveness on the world markets.

• Indicates the pressure on a country’s foreign reserves and its currency.


7

BOP accounts

• They are records of different transactions.– Any payment out is recorded as a debit (“-”)– Any payment in is recorded as a credit (“+”)

• Types of accounts– Current account (CA)– Capital account (KA)– Official reserves account (ORA)


8

Current account (CA)

• It is the net flow of goods, services, and unilateral transactions (gifts) between countries.

• Example:Debits CreditsGift to a foreigner Export of wheatImport of coffee Profits from a US firm

abroadTourists in Germany Leasing a ship to India


9

Capital account (KA)

• It is the net result of public and private international investment and lending activities.

• Example:Debits CreditsPurchase of JPY Sale of JPY (Yen)Receipt of CHF Payment for shares.


10

Official reserves account (ORA)

• It is the net holdings of gold and foreign currencies by official monetary institutions.

• Example:Debits Credits

Purchase of EUR Sale of gold


11

Deficit vs. surplus

• A country incurs a deficit (of one of its accounts), if it spends abroad more than what it earns or receives from other countries.

Debits > Credits

• A country incurs a surplus, if it spends abroad less than what it earns or receives from other countries.

Debits < Credits


12Relations among BOP accounts

• Since each account is a net supply or demand for a currency,

CA + KA + ORA = 0

CA + KA = BOP

• Therefore,

BOP = -ORA

2. Some Macroeconomic Relations


14

NotationsY - national incomeC - private consumption

I - investment G - government expenditure

X - exports M - imports

S - savings T - taxes

RF - net transfers from foreigners

RI - net investment income (the difference between the income of citizens of a given country abroad and foreign citizens in that country)


15

GNP vs. GDP

• GNP - gross national product produced by citizens of a given country

• GDP - gross domestic product produced within the borders of a given country

A question:What is larger: GDP or GNP?


16

Major macroeconomic relations

Y = GNP + RF

GNP = C + I + G + X - M

GDP = GNP - RI


17

More relationsY = C + I + G + X - M + RF = C + S + T

E = C + I + G = C + I + G

Y - E = X - M + RF = (S - I) + (T - G)

CA = X - M + RF


18

How to understand these relations

• If a country’s expenditure is more than its income, that is, Y - E < 0, then that country:– Imports more than exports– Invests more than saves– Runs a government budget deficit

• If a country’s expenditure is less than its income, that is, Y - E > 0, then that country:– Exports more than imports– Saves more than invests– Runs a government budget surplus

3. The Link between BOP and Exchange Rates


20

Relation of BOP to exchange rates: Floating exchange rates

• Under floating exchange rate regime (“free float”), the exchange rate is determined by the laws of supply and demand.

• This means no government intervention.

• Therefore,

ORA = 0 or CA = - KA


21Determinants of home currency supply and demand: floating

rates• What does increase the demand for home

currency?– Exports– Foreign investment in the home country

• What does increase the supply for home currency?– Imports– Home country investment abroad


22Economic intuition behind

CA < 0 • The current account deficit implies that

– imports > exports– the current supply of home currency > the

current demand for home currency– there exists a net demand for

“investments” in home currency– there is more investments by foreigners in

a country than by country’s citizens abroad– KA is in surplus


23Economic intuition behind

CA > 0 • Current account surplus implies that

– imports < exports– the current supply of home currency < the

current demand for home currency– there exists a net supply for “investments”

in home currency– there is less investments by foreigners in a

country than by country’s citizens abroad– KA is in deficit


24Relation of BP to exchange rates: Fixed exchange

rates• Under fixed exchange rates the exchange rate is fixed or varies within a narrow band.

• Any excess market demand for a home currency is supplied by the government.

• Any excess market supply for a home currency is adsorbed by the government.

• Therefore,CA = - (KA + ORA)


25

Determinants of home currency supply and demand: fixed rates

• What does increase the demand for home currency?– Exports– Foreign investment in the home country– Government’s purchase of the home currency

• What does increase the supply for home currency?– Imports– Home country investment abroad– Government’s sell of the home currency

4. Comments on Current Account deficit


27How to “cure” the CA deficit: Argument 1

• Make home currency depreciate:– Increase the demand for home products

abroad– Decrease the demand for foreign products

at home– Decrease the amount of foreign

investments


28

The U.S. evidence

• In the mid 1980s, the U.S. dollar was very strong

• Foreign investment in the U.S. decreased

• The demand for and, as a result, the value of the U.S. dollar declined

• There was some increase in exports


29

Did it work? - No!

• The CA deficit did not decline

Why?

• The U.S. continued to spend in excess of its national income (Y - E < 0)


30

How to “cure” the CA deficit: Argument 2

• Introduce import restrictions:– Prohibit import of particular products– Increase the price of imports– Introduce quotas on foreign goods


31

Will it work? – Not sure

• Restriction of foreign goods decrease domestic demand for foreign currency

• Home currency appreciates• Exports become more expensive for

foreigners• The volume of exports decrease• There is less trade between home country

and outside world• Everyone has lost


32

Conclusions

• With floating exchange rates, any given value of the home currency can neither cause problems in the balance of payments nor solve them.

• While there is a fundamental linkage between exchange rates and the balance of payments, things sometimes work differently.

• Current account deficit is not necessarily a bad thing.

Date post:	02-Jan-2016
Category:	Documents
Upload:	angelica-johns
View:	217 times
Download:	1 times

The Balance of Payments. © 2002 by Stefano Mazzotta 1 Learning Outcomes 1. Definition of the...

Documents