8/6/2019 Eun Resnick Balance of Payment

1/31

8/6/2019 Eun Resnick Balance of Payment

2/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-1

ChapterThree Outline

Balance of Payments Accounting

Balance of Payments Accounts

The Current Account The Capital Account

Statistical Discrepancy

Official Reserves Account

The Balance of Payments Identity

Balance of Payments Trends in MajorCountries

8/6/2019 Eun Resnick Balance of Payment

3/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-2

Balance of Payments Accounting

The Balance of Payments is the statistical record

of a countrys international transactions over a

certain period of time presented in the form ofdouble-entry bookkeeping.

N.B. when we say a countrys balance ofpayments we are referring to the transactions of

its citizens and government.

8/6/2019 Eun Resnick Balance of Payment

4/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-3

Balance of Payments Example

Suppose that Maplewood Bicycle inMaplewood Missouri, USA imports

$100,000 worth

of bicycle frames fromMercian Bicycles in Darby England.

There will exist a $100,000 credit recordedby Mercian that offsets a $100,000 debit at

Maplewoods bank account. This will lead to a rise in the supply of

dollars and the demand for British pounds.

8/6/2019 Eun Resnick Balance of Payment

5/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-4

The balance of payments accounts are those that

record all transactions between the residents of a

country and residents of all foreign nations. They are composed of the following:

The Current Account

Th

e Capital Account Statistical Discrepancy

The Official Reserves Account

Balance of Payments Accounts

8/6/2019 Eun Resnick Balance of Payment

6/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-5

The Current Account

Includes all imports and exports of goods and

services.

Includes unilateral transfers of foreign aid. If the debits exceed the credits, then a country is

running a trade deficit.

8/6/2019 Eun Resnick Balance of Payment

7/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-6

The Capital Account

The capital account measures the difference

between U.S. sales of assets to foreigners and U.S.

purchases of foreign assets. The U.S. enjoys about a $150,000,000,000 capital

account surplusabsent of U.S. borrowing from

foreigners, this finances our trade deficit.

The capital account is composed of Foreign Direct

Investment (FDI), portfolio investments and other

investments.

8/6/2019 Eun Resnick Balance of Payment

8/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-7

Statistical Discrepancy

Theres going to be some omissions and

misrecorded transactionsso we use a plug

figure to get things to balance. Exhibit 3.1 shows a discrepancy of $96.76 billion

in 1997.

8/6/2019 Eun Resnick Balance of Payment

9/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-8

The Official Reserves Account

Official reserves assets include gold, foreign

currencies, SDRs, reserve positions in the IMF.

8/6/2019 Eun Resnick Balance of Payment

10/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-9

The Balance of Payments Identity

BCA + BKA + BRA = 0

where

BCA = balance on current accountBKA = balance on capital account

BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0

8/6/2019 Eun Resnick Balance of Payment

11/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-10

U.S. Balance of Payments Data

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

8/6/2019 Eun Resnick Balance of Payment

12/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-11

U.S. Balance of Payments Data

In 1997, the

U.S. imported

more than it

exported, thus

running a

current account

deficit of$166.8 billion.

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

8/6/2019 Eun Resnick Balance of Payment

13/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-12

U.S. Balance of Payments Data

During the same

year, the U.S.

attracted net

investment of

$264.58

billionclearly

the rest of the

world found the

U.S. to be a

good place to

invest.

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

8/6/2019 Eun Resnick Balance of Payment

14/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-13

U.S. Balance of Payments Data

Under a pure

flexible

exchange rate

regime, these

numbers would

balance each

other out.

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

8/6/2019 Eun Resnick Balance of Payment

15/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-14

U.S. Balance of Payments Data

In the real

world, there

is a statistical

discrepancy.

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

8/6/2019 Eun Resnick Balance of Payment

16/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-15

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

U.S. Balance of Payments Data

Including that,

the balance of

payments identity

should hold:

BCA + BKA = - BRA

($166.80) + $264.58 + ($96.76) = $1.02= ($1.02)

8/6/2019 Eun Resnick Balance of Payment

17/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-16

Balance of Payments and the

Exchange Rate

Q

P S

D

Exchange rate $

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

8/6/2019 Eun Resnick Balance of Payment

18/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-17

Balance of Payments and the

Exchange Rate

Q

P S

D

Exchange rate $

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

As U.S. citizens import, they are supply dollars to the FOREX market.

8/6/2019 Eun Resnick Balance of Payment

19/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-18

Balance of Payments and the

Exchange Rate

Q

P S

D

Exchange rate $

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

As U.S. citizens export, others demand dollars at the FOREX market.

8/6/2019 Eun Resnick Balance of Payment

20/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-19

Balance of Payments and the

Exchange Rate

Q

P S

D

Exchange rate $

Credits Debits

Current Account

1 Exports $1,167.61

2 Imports ($1,295.53)

3 Unilateral Transfers $6.13 ($45.01)Balance on Current Account ($166.80)

Capital Account

4 Direct Investment $107.93 ($119.44)

5 Portfolio Investment $387.62 ($79.28)

6 Other Investments $194.95 ($227.2)Balance on Capital Account $264.58

7 Statistical Discrepancies ($96.76)Overall Balance $1.02

Official Reserve Account ($1.02)

As the U.S. government sells dollars, the supply of dollars increases.

S1

8/6/2019 Eun Resnick Balance of Payment

21/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-20

Balance of Payments Trends

Since 1982 the U.S. has experienced continuous

deficits on the current account and continuous

surpluses on the capital account. During the same period, Japan has experienced the

opposite.

8/6/2019 Eun Resnick Balance of Payment

22/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-21

Balance of Payments Trends

U.S. Balance of Payments Trends

-200

-150

-100

-50

0

50

100

150

200

1982

1984

1986

1988

1990

1992

1994

1996

Year

Balance

ofPayments($b

)

Current Account

Capital Account

8/6/2019 Eun Resnick Balance of Payment

23/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-22

Balance of Payments Trends

Japan's Balance of Payments Trend

-150

-100

-50

0

50

100

150

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

Year

Balance

ofPayments($b

)

Current Account

Capital Account

8/6/2019 Eun Resnick Balance of Payment

24/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-23

Balance of Payments Trends

Germany traditionally had current account

surpluses.

Since 1991 Germany has been experiencingcurrent account deficits.

This is largely due to German reunification and

the resultant need to absorb more outputdomestically to rebuild the former East Germany.

What matters is the nature and causes of the

disequilibrium.

8/6/2019 Eun Resnick Balance of Payment

25/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-24

Balance of Payments Trends

Germany's Balance of Payments Trend

-80

-60

-40

-20

0

20

40

60

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

Year

Balance

ofPayments($b)

Current Account

Capital Account

8/6/2019 Eun Resnick Balance of Payment

26/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-25

REASONS OF DISEQUILIBRIUM IN

BALANCE OF PAYMENT

Fundamental Disequilibrium long run BOPdisequilibrium of a country. This may be due to factorslike :

- Changes in consumer tastes within the country orabroad which reduces exports and increases imports ofa country.

- Continuous fall in countrys foreign exchangereserves due to supply inelasticity of exports and

excessive demand for foreign goods and services.

8/6/2019 Eun Resnick Balance of Payment

27/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-26

- Excessive capital outflows to high imports.

- Low competitive strength in world markets.

- Inflationary pressures which makes exportsdearer.

Structural Changes- Technological Changes

- Import restrictions

- Deficit in BOP due to import of resources

8/6/2019 Eun Resnick Balance of Payment

28/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-27

Cyclical Fluctuations

Change in National Income w

hich

increaseimports and thus deficit in BOP.

Change in Exchange Rates

Capital Movements

Political and Economic Conditions

8/6/2019 Eun Resnick Balance of Payment

29/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-28

Measures to Correct BOP Deficit

Adjustments through Depreciation of

Countrys currency.

Devaluation / Expenditure or SwitchingPolicy

Direct Control by introducing tariff and non-

tariff barriers, import duty and excise duty

etc.

Adjustment through Capital Inflow by

increasing the domestic rate of interest.

8/6/2019 Eun Resnick Balance of Payment

30/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-29

Adjustment through Income Changes by

increasing the demand for and exports.

Simulation of Export and Import Substitutes

Expenditure reducing policies like

contractionary monetary and fiscal policies

which leads to increase in domestic interestrate to reduce money supply and reduction

government expenditure and or increase in

taxes.

8/6/2019 Eun Resnick Balance of Payment

31/31

McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hill Companies, Inc. All rights3-30

End ChapterThree