1. Balance of Payments

2. Lesson Objectives Outline the role of balance of payments.
Explain the four components of the current account.
Explain how current account deficits and surpluses can affect exchange rates.

3. Balance of Payments
The balance of payments of a country is a record (usually for a year) of all transactions between the people of one country and the people from all other countries.
Payments received from other countries are called credits, payments to other countries are called debits.

4. Balance of Payments The balance of payments has three components
Current account
Capital account
Financial account

5. Current Account
Measures the flow of funds from trade in goods and service, plus other income flows.
Usually subdivided into four parts
Balance of trade in goods
Balance of trade in services
Income
Current transfers

6. Current Account Balance of trade in goods (exports - imports)
Exports (credits)
Imports (debits)
Balance of trade in services (tourism, education, insurance, consulting, etc.) (exports - imports)

7. Current Account Current transfers Income
Net movement of profit, interest, dividends
Current transfers
Gifts, foreign aid, remittances and pensions

8. Current Account
Current account balance = balance of trade in goods + balance of trade in services + net income flow + net transfers

9. Current Account Current Account Exports of goods +40 Imports of goods
-65
Balance of trade in goods
Exports of services
+25
Imports of services
-15
Balance of trade in services
Balance of trade in goods an services
Income -6
Current transfers +1
Balance on current account

10. Surplus and Deficits Surplus – when a balance has a positive value
Deficit – when a balance has a negative value

11. Capital account Relatively small Capital transfers
Debt forgiveness, financial assets of migrants, sale of fixed assets, gift taxes, and inheritance taxes
Transactions in non-produced, non-financial assets
Net sales of land, natural resource rights, patents, copyrights, brand names, franchises

12. Capital account
Capital account balance = capital transfers + transactions in non-produced, non-financial assets

13. Capital account Capital Account Capital transfers +0.7
Transactions of non-produced, non-financial products
+0.3
Balance on Capital Account

14. Financial Account
Direct investment (investment leading to lasting share in a company or economy)
Buying property, stocks,
Portfolio investment (Buying of stocks and bond which do not give lasting interest in a company or economy)
Buying treasury bills and government bonds, savings account deposits
Reserve assets (money reserves that the central bank can buy or sell)
It is movements in and out of this account that ensure that the balance of payments is always zero

15. Financial Account
Financial account balance = net direct investment + net portfolio investment + change in reserve assets

16. Financial Account Financial Account Direct investment +23
Portfolio investment -4
Reserve assets +1
Balance on financial account

17. Balance of Payments Balance of Payments Balance on current account -20
Balance on capital account +1
Balance on financial account
+20
Errors and Omissions

18. Balance of Payments
In a given year, all credits must exactly equal all debits.
Current account = capital account + financial account + net errors and omissions

19. Current Account and Foreign Exchange
In the current account of a country:
All credits create a foreign demand for the country’s currency
All debits create a supply of the country’s currency

20. Current Account and Foreign Exchange
Deficit in current account causes downward pressure on the exchange rate
Surplus in current account causes downward pressure on the exchange rate

21. Consequences of a current account deficit
Decreased foreign exchange reserves
Increased foreign ownership of domestic assets
Increased foreign debt
Need for higher interest rates
Decreased exchange rate

22. Consequences of a current account surplus
Increased foreign exchange reserves
Increased domestic ownership of foreign assets
Increased exchange rate

23. How to correct a current account deficit?
Expenditure switching policies (trying to change imports and exports)
Exchange rate changes
Protectionist measures

24. How to correct a current account deficit?
Expenditure reducing policies (trying to reduce spending)
Deflationary fiscal policy
Deflationary monetary policy