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NATIONAL INCOME
GDP: National Spending = National Income
Y = C + I + G + X M
Y = GDP; C = Consumption; I = PhysicalInvestment; G = Government Spending; X =
Exports; M = Imports GNP
NNP
Current prices
Constant prices
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BALANCE OF PAYMENTS
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WHYDO COUNTRIES TRADE?
Trade is simply buying and selling goods andservices from other countries.
Imports: The purchase of goods and services fromforeign countries leading to outflow of currency.
Export: The sale of goods and services leading toinflow of foreign currencies.
But what really prompts countries to do thesetrades?
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WHYDO COUNTRIES TRADE?
Different countries according to various factors havedifferent levels of efficiency in producing differentgoods.
Comparative Advantage
When a country can produce goods at lower opportunitycost i.e. it sacrifices less resources in production.
Absolute Advantage
When a country can produce goods with fewer resources
than another country.
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WHYDO COUNTRIES TRADE?
Countries Good 1 Good 2
Country A 5 2.5
Country B 10 20
Total 15 22.5
A unit of labour can produce either 10 Good1 or 5Good2 in country A, and a unit of labour in countryB can produce either 20 Good1 or 40 Good2.
Thus opportunity cost of producing additional
Good2 is high in country A, and opportunity cost forproducing Good1 is higher in country B.
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WHYDO COUNTRIES TRADE?
Countries Good 1 Good 2
Country A 10 0
Country B 5 30
Total 15 30
Now suppose the countries produce the goods in whichthey have minimum opportunity cost i.e. they achievespecialisation in the suitable good and then trade.
Larger quantities will be produced and they will havemutual benefits.
Below is Table for such production.(Lets suppose stillCountry B produces good 1 due to fear of shortage)
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INTRODUCTIONABOUT BOP
All modern economies prepare and publish thisNational Accounts.
A record of all the factors, which create the demandfor, and the supply of the countrys currency.
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DEFINATION
The Balance of Payments of a country is asystematic accounting record of all economictransactions during a given period of time betweenthe residents of the country and residents of foreign
countries.
The phrase residents of foreign countriesmay often be replaced by nonresidents,foreigners orrest of the world (ROW).
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BALANCE OF PAYMENTS
A countrys balance of payments accounts keeptrack of both its payments to and its receipts fromforeigners.
Any transaction resulting in a payment to foreignersis entered in the balance of payments accounts asa debit and is given a negative () sign.
Any transaction resulting in a receipt fromforeigners is entered as a credit and is given a
positive (+) sign.
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WHATISECONOMICTRANSACTIONS?
By this we mean transfer of economic value fromone economic agent (individual, business,government, etc.) to another.
Something in return.
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THEFOLLOWINGBASICTYPESOFECONOMICTRANSACTIONSCANBEIDENTIFIED:
1. Purchase or sale of goods or services with afinancial quid pro quo- or a promise to pay. Onereal and one financial transfer.
2. Purchase or sale of goods or services in return for
goods or services or a barter transaction. Tworeal transfers.
3. An exchange of financial items e.g. purchase offoreign securities with payment in cash or by acheque drawn on a foreign deposit. Two financialtransfers.
4. A unilateral gift in kind. One real transfer.
5. A unilateral financial gift. One financial transfer.
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COMPONENTS OF THEBALANCE OF PAYMENTS
(a) The Current Account: Under this are includedimports and exports of goods and services andunilateral transfers of goods and services.
(b) The Capital Account: Under this are groupedtransactions leading to changes in foreign assetsand liabilities of the country.
(c) The Reserve Account:
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THECURRENTACCOUNT
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CONT.
Cr Dr Net
(b) Transfers6 Official7 Private
(c) Income(i) Investment Income(ii) Compensation to Employees
Total Current Account (I + II)
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THE CAPITAL ACCOUNT
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THE OTHER ACCOUNTS
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STATISTICAL DISCREPANCY
Theres going to be some omissions andmisrecorded transactionsso we use a plugfigure to get things to balance.
Exhibit 3.1 shows a discrepancy of $0.73 billion in2000.
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THE BALANCEOF PAYMENTSIDENTITY
BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,
BCA + BKA = 0
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U.S. BALANCEOF PAYMENTS DATA
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
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U.S. BALANCEOF PAYMENTS DATA
In 2000, the U.S.
imported more than it
exported, thus running
a current accountdeficit of $444.69
billion.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
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U.S. BALANCEOF PAYMENTS DATA
During the same year,
the U.S. attracted net
investment of $444.26
billionclearly the rest
of the world found theU.S. to be a good place
to invest.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
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U.S. BALANCEOF PAYMENTS DATA
Under a pure flexible
exchange rate regime,
these numbers would
balance each other
out.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
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U.S. BALANCEOF PAYMENTS DATA
In the real world,
there is a statistical
discrepancy.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
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U.S. BALANCEOF PAYMENTS DATA
Including that, the
balance of payments
identity should hold:
BCA + BKA =BRA
($444.69) + $444.26+ $0.73 = $0.30=
($0.30)
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
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BALANCEOF PAYMENTSANDTHE EXCHANGE RATE
Q
P
Exchange rate $Credits DebitsCurrent Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
S
D
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BALANCEOF PAYMENTSANDTHE EXCHANGE RATE
Q
P
As U.S. citizens import, they are supply dollars to the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
Exchange rate $
S
D
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BALANCEOF PAYMENTSANDTHE EXCHANGE RATE
Q
P S
D
As the U.S. government sells dollars, the supply of dollars increases.
S1
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account ($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account $444.26
7 Statistical Discrepancies
Overall Balance $0.30
Official Reserve Account ($0.30)
0.73
Exchange rate $
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ACCOUNTING PRINCIPLESIN BALANCE OF PAYMENTS
One credit & One debit.
Tt. of cr must match Tt. of dr.
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CONT. RULE A
All transactions which lead to an immediate orprospective payment from the rest of the world(ROW) i.e. nonresidents, to the country in questioni.e. residents of that country, should be recorded as
credit entries in the BOP of that country and viceversa.
A payment received from the ROW increases thecountrys foreign assets - either the payment will becredited to a bank account held abroad by a
resident entity or a claim is acquired on a foreignentity. Thus an increase in foreign assets (or adecrease in foreign liabilities) must appear as adebit entry
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RULE B
A transaction which results in an increase indemand for foreign exchange or decrease in supplyof foreign exchange is to be recorded as a debitentry (imports)
while a transaction which results in an increase inthe supply of (or decrease in demand for) foreignexchange is to be recorded as a credit entry.
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Capital outflowe.g. when a resident purchasesforeign securities or pays off a foreign bank loanuses up foreign exchange and hence is a debitentry while a capital inflow e.g. disbursement of
loan by a foreign bank to a resident firm increasesavailability of foreign exchange and therefore is acredit entry.
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BALANCE OF PAYMENTS
Case Study: Is the United States the Worlds
Biggest Debtor?
At the end of 1999, the United States had anegative net foreign wealth position far greater
than that of any other single country.
The United States is the worlds biggest debtor.
However, the United States has the worldslargest GNP.
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