Balance of Payments

Chapter Three
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
 Overview
• Balance of Payments Accounting
• Balance of Payments Accounts
– The Current Account
– The Capital Account
– The Financial Account
– Statistical Discrepancy
– Official Reserves Account
• The Balance of Payments Identity
• Balance of Payments Trends in Major Countries

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-2
 Balance of Payments Accounting
• Balance of payments is the statistical record of a
country’s international transactions over a certain
period of time presented in the form of double-entry
bookkeeping
• Important to study for a few reasons:
1. Provides detailed information concerning the demand and
supply of a country’s currency
2. May signal its potential as a business partner for the rest
of the world
3. Used to evaluate the performance of the country in
international economic competition
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-3
 Balance of Payments Accounting (Continued)
• Any transaction that results in a receipt from
foreigners will be recorded as a credit, with a positive
sign, in the U.S. balance of payments
– E.g., foreign sales of U.S. goods and services, goodwill,
financial claims, and real assets
• Any transaction that gives rise to a payment to
foreigners will be recorded as a debit, with a negative
sign, on the U.S. balance of payments
– E.g., U.S. purchases of foreign goods and services,
goodwill, financial claims, and real assets

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-4
 Balance of Payments Accounts
• International transactions can be grouped into the
following four main types:
1. Current account includes the export and import of goods
and services
2. Capital account consists of capital transfers and the
cross-border acquisition and disposal of nonproduced
nonfinancial assets
3. Financial account (excluding official reserves) includes
all purchases and sales of financial assets, such as stocks,
bonds, bank accounts, etc.
4. Official reserve account covers all purchases and sales
of international reserve assets
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-5
Summary of the U.S. Balance of Payments for 2018
($b)

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-6
 The Current Account
• Divided into four finer categories:
1. Goods trade represents exports and imports of tangible
goods (e.g., oil, wheat, clothes, automobiles, computers,
etc.)
2. Services include payments and receipts for legal,
consulting, financial, and engineering services, royalties
for patents and intellectual properties, shipping fees, and
tourist expenditures
3. Primary income consists largely of payments and
receipts of interest, dividends, and other income on
foreign investments that were previously made
4. Secondary income involves “unrequited” payments
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-7
 The Current Account (Continued)
• Current account balance, especially the trade balance,
tends to be sensitive to exchange rate changes
– Currency depreciation or devaluation can improve
(worsen) the trade balance if imports and exports are
responsive (inelastic)
• J-curve effect refers to the initial deterioration and
eventual improvement of trade balance following the
depreciation of a country’s currency

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-8
 The Financial Account
• Measures the difference between U.S. sales of assets
to foreigners and U.S. purchases of foreign assets
• Can be divided into three categories:
1. Foreign direct investment (FDI) occurs when the
investor acquires a measure of control of the foreign
business
2. Portfolio investment mostly represents sales and
purchases of foreign financial assets, such as stocks and
bonds, that do not involve a transfer of control
3. Other investment includes transactions in currency, bank
deposits, trade credits, etc.

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-9
 Statistical Discrepancy
• Exhibit 3.1 shows a statistical discrepancy of -
$40.5 billion in 2018
– Recordings of payments/receipts arising from international
transactions are done at different times and places, possibly
using different methods
– Financial transactions may be mainly responsible for
discrepancy
• Overall balance is the cumulative balance of
payments including the current account, capital
account, financial account, and the statistical
discrepancies
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-10
 The Official Reserves Account
• Official reserve account includes transactions
undertaken by the authorities to finance the overall
balance and intervene in foreign exchange markets
• Post-1945, international reserve assets comprise:
1. Gold
2. Foreign exchanges
3. Special drawing rights (SDRs)
4. Reserve positions in the IMF

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-11
 The Balance of Payments Identity (BOPI)
BCA + BKA + BFA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BFA = balance on financial account
BRA = balance on the reserves account

• Under fixed exchange regime, countries maintain

official reserves that allow them to have BOP
disequilibrium
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-12
 BOP Trends in Major Countries
• U.S. has experienced continuous deficits on the
current accounts since 1982 and continuous surpluses
on the financial account; with the sole exception of
1991
– Magnitude of U.S. current account deficits is far greater
than any that other countries ever experienced during the
36-year sample period
• Japan has had an unbroken string of current account
surpluses (and financial account deficits) since 1982
even though the value of the yen rose steadily until
the mid-1990s
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-13
 BOP Trends in Major Countries (Continued)
• U.K. recently experienced continuous current account
deficits, coupled with financial account surpluses
– Magnitude is far less than that of the U.S.
• Germany traditionally had current account surpluses,
but between 1991-2001 experienced current account
deficits
– Attributed to German reunification and the resultant need
to absorb more output domestically to rebuild the East
German region
– Since 2002, Germany has returned to their earlier pattern

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-14
 BOP Trends in Major Countries (Concluded)
• China tends to have a surplus on the current account,
as well as the financial account (until recently)

• “Global imbalance”
– Overall, U.S. and U.K. generally use up more outputs than
they produce, whereas the opposite holds for China, Japan
and Germany

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-15
Top U.S. Trading Partners, 2018 ($b)

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved. 3-16