2 The Balance of PaymentThe balance of payments of a country is a systematic record of a country’s trade in goods, services, and financial assets between residents of that country and the rest of the world during a given period of timePrivate transactions (individuals and business firms)Official transactions (government transactions)
3 Economic TransactionAny transaction has two sides. From the point of view of home country, the two sides are defined as:Credit: Are those transactions that will bring foreign exchange into the countryDebit: Are those transactions that would mean a loss of foreign exchange
4 The Balance of PaymentTable 12.1 provides an example of the historic detailed balance of payments for the United StatesSimplified US balance of Payments for 2000
5 Simplified US Balance of Payments for 2000 (billions $) CreditsDebitsNetMerchandise7721224-452Services29221874Income35333122Unilateral transfers-53Current Account-410US-owned assets abroad-606Foreign-owned assets1015Capital AccountStatistical Discrepancy409.8
6 Current accountIncludes the value of trade in merchandise, services, income, and unilateral transfersFigure 12.1 shows change in balance of payments over timeCurrent account excludes capital account transactions – purchases and sales of financial assets
8 Financing Current Account: Large current account deficit means large capital account surplus.Important items included in the capital account:Direct InvestmentSecurity purchasesBank claims and liabilitiesU.S. government assets abroadForeign official assets in the United States
9 Capital AccountOne implication of capital account transaction pertains to the net creditor or net debtor position of a nation.A net debtor owes more to the rest of the world than it is owed.A net creditor is owed more than it owes.
10 National Savings, Investment and Current Account Y=C+I+G+XWhere:Y = National incomeC= Consumption spendingI = Investment spendingG=Government spendingX=Net export or the current account
11 National Savings, Investment and Current Account Rearranging the above equation:Y-C-G=I+X=SWhere S = national savingThe above relationship indicates that national saving is equal to the sum of investment saving plus the current account balance.Thus, current account must be equal to:X=S-I
12 National Savings, Investment and Current Account The country where investment greater than saving, spending greater than income, has a current account deficit.The country where saving greater than investment, income greater than spending, has a current account surplus.
13 The World’s Largest Debtor September 10, 1985 US became a debtor nationIn 1982 US reached its all-time high as a net creditor ($147 billion)By 1985 US had massive current account deficits and corresponding capital account surplusesOn September 1985, the U.S. Commerce department announced that the United States was a debtor nation for the first time since world war I.The magnitude of current account deficit in 1985 and 1986 made the U.S. the largest international debtor in the world with debt exceeding Mexico and Brazil.
14 The World’s Largest Debtor To consume more at home then is produced, the US must borrow from abroadUS borrowed at high levelLarge reduction in US foreign lendingUS federal budget deficits made lending at home more attractive
15 The World’s Largest Debtor What can change this position?If dollar-denominated assets are no longer desired, dollar will tend to depreciate, interest rates will fallCapital account surplus will equal to falling current account deficitUS will become a net lender
16 Additional Summary Measures Balance-of-merchandise tradeOfficial settlements balance is the value of the change in financial assets held by foreign monetary agencies and official reserve asset transactions
17 Transactions classification 1)US bank makes a loan of $1 million to a Romanian food processor. This loan is funded by creating $1 million deposit for the Romanian firm in the US bank2)US firm sells $1 million worth of wheat to the Romanian firm. The wheat is paid with the bank account created in transaction 13)US resident receives $10,000 in interest from German bonds she owned. The $10,000 is deposited in a German bank4) A US tourist travels to Europe and spends the $10,000 German deposit
18 Balance of Payments Credit (+) Debit (-) Net Bal. Merchandise $1 mil (2)Services10,000 (4)Income10,000(3)Unilateral transfersCurrent account$+1 milOfficial capitalPrivate capital$1 mil (1)10,000 (3)Totals$2,020,000
19 Balance of Payments Equilibrium and Adjustment Economic implications of the balance of paymentsGlobal current account balance has summed to deficit in recent years due to inaccurate measurement of international financial transactions (service transactions)2-country example of bilateral trade imbalances (A is a wealthy creditor country and B is a poor country that run trade surpluses with ABalance of payments equilibrium – exports equal imports or credits equal debits for a particular account (current account or official settlements account)
20 Balance of Payments Equilibrium and Adjustment Current account equilibrium for a nation would mean unchanging net creditor or debtor position, no need for net financingEquilibrium on official settlements would mean no change in our financial assets held by foreign monetary agencies and reserve assets
21 Balance of Payments Equilibrium and Adjustment There is a disequilibrium in the balance of payments, in official settlements partDeficit countries will experience reserve asset losses and surplus countries – reserve accumulationInternational reserve assets are composed of gold, IMF special drawing rights, and foreign exchangeLets consider change in international reserve assets based on foreign exchange along
22 Balance of Payments Equilibrium and Adjustment 1 British pound is worth 1.50 US dollarsSupply-demand for foreign exchange marketDemand for pounds comes from US demand for British goods or financial assetsSupply of pounds comes from British buyers of US goods or financial assetsUpward sloping supply curve implies that as pound appreiciates in value US products are cheaper to Br. Buyers, more pounds supplied to this market
23 Balance of Payments Equilibrium and Adjustment Equilibrium is restored at the new equil. PointFlexible exchange rates - free market supply and demand determines the value of currenciesFixed exchange rates –central banks set exchange rates at desired levelsDeveloping countries use direct controls on international trade to shift supply/demand curves