International Economics Tenth Edition CHAPTER T H I R T E E N 13 International Economics Tenth Edition Balance of Payments Dominick Salvatore John Wiley & Sons, Inc. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Learning Goals: Understand what the balance of payment is and what it measures Describe the change in the U.S. balance of payments over the years Understand the importance of the serious deterioration of the trade balance and net international investment position of the United States in recent years. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Introduction The balance of payments provides a summary statement of international transactions for a nation for a specified period of time. An international transaction is the exchange of a good, service or asset between residents of one nation and residents of another nation. The main purpose of the balance of payments is to help the government in formulation monetary, fiscal and trade policies. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles Credit transactions (+) Transactions that involve receipt of payments from foreign sources. Major types: Exports of goods and services Unilateral transfers (gifts) from foreigners Financial inflows Increase in foreign assets in a nation Reduction in a nation’s assets abroad Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles Debit transactions (-) Transactions that involve payment to foreign sources. Major types: Imports of goods and services Unilateral transfers (gifts) to foreigners Financial outflows Increase in a nation’s assets abroad Reduction in foreign assets in a nation Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles In balance of payment accounting, each international transaction is recorded twice – once as a credit, once as a debit. Examples: $500 in exports to be paid in 3 months time Credit (+) Debit (-) Goods export $500 Financial outflow Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles In balance of payment accounting, each international transaction is recorded twice – once as a credit, once as a debit. Examples: $200 spent by a U.S. tourist in London on services Credit (+) Debit (-) Travel services (purchased from foreigners) $200 Financial inflow Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles In balance of payment accounting, each international transaction is recorded twice – once as a credit, once as a debit. Examples: $100 in US government foreign aid given to the government of a developing nation Credit (+) Debit (-) Unilateral transfers made $100 Financial inflow Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles In balance of payment accounting, each international transaction is recorded twice – once as a credit, once as a debit. Examples: $400 in foreign stock purchased by U.S. resident Credit (+) Debit (-) Financial outflow (purchase of foreign stock by U.S resident) $400 Financial inflow (increase in foreign bank balances in U.S.) Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Balance of Payments Accounting Principles In balance of payment accounting, each international transaction is recorded twice – once as a credit, once as a debit. Examples: $300 of U.S. Treasury bills purchased by foreign investor from his U.S. bank account Credit (+) Debit (-) Financial inflow (purchase of U.S. Treasury bills by foreigner) $300 Financial outflow (reduction in foreign bank balances in U.S.) Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The International Transactions of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The International Transactions of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Accounting Balances and the Balance of Payments Current Account All sales and purchases of currently produced goods and services, investment incomes and unilateral transfers, providing link between international transactions and national income. Current account surplus stimulates domestic production and income Current account deficit dampens domestic production and income Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Accounting Balances and the Balance of Payments Capital Account Includes debt forgiveness and goods and financial assets that migrants take with them as they leave or enter the country. The U.S. deficit in the current and capital accounts in 2007 are financed or covered by an equal net inflow of capital abroad. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Accounting Balances and the Balance of Payments Financial Account Shows the change in U.S.-owned assets abroad and foreign-owned assets in the United States. The U.S. covers its current and capital account deficits with an equal net financial account surplus. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Accounting Balances and the Balance of Payments If net private capital inflows do not cover the current and capital accounts deficit, the nation has a deficit in its balance of payments equal to the difference, which needs to be covered by a net credit balance on official (i.e., monetary authorities’) reserve transactions. Official settlements balance - The balance on official reserve transactions, also called the balance of payments. Official reserve account – The account in which official reserve transactions are entered. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Accounting Balances and the Balance of Payments Current account balance + capital account balance + financial account balance (less official reserve transactions, but including net balance of financial derivatives) + statistical discrepancy Balance of Payments Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Accounting Balances and the Balance of Payments Deficit in the balance of payments (negative sum of account balances) - covered by an equal amount official reserves transaction (reduction in international reserves of the nation or increase in foreign holdings of official assets of the nation). Surplus in the balance of payments (positive sum of account balances) - settled by an increase in the nation’s international reserves and/or reduction in foreign official holdings of nation’s assets. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The Postwar Balance of Payments of the United States Points to keep in mind when examining balance of payments: Too much attention is usually placed on balance of goods and short term data. Dangerous to extrapolate for year based on quarterly data. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The Postwar Balance of Payments of the United States Points to keep in mind when examining balance of payments: International transactions are closely interrelated rather than independent. For example, cutting U.S. foreign aid programs also reduces ability of recipients to import U.S. goods, so improvement in U.S. balance of payments may be much less than reduction in aid. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The Postwar Balance of Payments of the United States Points to keep in mind when examining balance of payments: An attempt to reduce the U.S. trade deficit with respect to a nation such as Japan is likely to reduce the U.S. surplus with respect to Brazil because Brazil pays for U.S. goods partly through natural resource exports to Japan. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The Postwar Balance of Payments of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The Postwar Balance of Payments of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The International Investment Position of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The International Investment Position of the United States A nation’s BOP measures international flow of goods, services and capital during a one- year period (flow concept). A nation’s international investment position measures total amount and distribution of assets abroad and foreign assets in the nation at the end of the year (stock concept). Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

The International Investment Position of the United States Also known as balance of international indebtedness. Useful in projecting the future flow of income from U.S. foreign investments and payments on foreign investments in the U.S. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

FIGURE 13-3 The U.S. Current Account Balance and the Net Investment Position, 1980-2011 Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Case Study 13-1 The Major Goods Exports and Imports of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Case Study 13-2 The Major Trade Partners of the United States Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Case Study 13-3 The U.S. Trade Deficit with Japan FIGURE 13-1 The U.S. Trade Balance with Japan in Goods and in Goods and Services, 1980-2011. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Case Study 13-4 The Exploding U.S. Trade Deficit with China FIGURE 13-2 U.S. Exports, Imports, and Net Trade Balance in Goods with China, 1985-2011 (billions of dollars). Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Appendix: The IMF Method of Reporting International Transactions Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Appendix: The IMF Method of Reporting International Transactions Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Appendix: The IMF Method of Reporting International Transactions Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

Appendix: The IMF Method of Reporting International Transactions Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

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