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Balance of Payments
4.5 and 4.7
IB Economics
Definition of Balance of
Payments
• All transactions between citizens and organizations of
a country and foreigners and foreign organizations.
Payments Received from Foreign Countries
•Exports and Imports of Goods (visibles)
•Exports and Imports of Services (invisibles)
•Tourist Expenditures
•Interest & Dividends Received
•Interest & Dividends Paid Abroad
•Purchases and Sales of Financial
or Real Assets Abroad
Payments Made to Foreign Countries
Components of Balance of
Payments Statement
Refer to Table 38.1 (page 713)
• The Current Account – goods and services that are
continuously traded
– Visibiles or Goods Account
– Invisibles or Services Account
– Current Account Balance (Inflows minus Outflows) or X-M
• The Capital Account – all foreign purchases of long term
and short term capital assets
– Record of asset transactions across international borders
– Balance of Capital Account (“Exported” Assets minus “Imported”
Assets)
– Official Reserves Account aka Currency Reserves
Net balance of payments = current account balance + capital account balance = 0
Balance of Payments:
Deficits and Surpluses
• Refers to imbalances between Current
& Capital Accounts
Deficits
•Drawing down of official reserves
•Reserves are limited, thus prolonged
deficits deplete the reserves
•To correct persistent deficits policy options:
•Macro adjustments
•Trade barriers
•Depreciation of its currency
Surpluses
•Building up of official reserves
•Negative official entry
A growing concern for the
United States economy! More
on this later in the semester…
4.7 Balance of Payments
Problems
• Here we bring together the international
topics of trade, protection, balance of
payments and exchange rates.
• We will also discuss the connection to
the macro economy – growth of output,
employment and inflation.
Influences on Balance of
Payments
• Change in Income – changes in relative
incomes will effect trade of visibles and
invisibles, and thus alter current account
balance.
• Example: increasing domestic income=
increase M and worsening current account
balance. This means the exchange rate will
depreciate.
• OR a recession in national income will
decrease import spending and strengthen
exchange rates.
Influences on Balance of
Payments
• Changes in Relative Prices – a change in the
relative inflation rate will have similar effects
as change in income.
• Example: If a country has a high inflation rate
relative to its main trading partners it will
export less to them and import more from
them. The current account will worsen and
the currency depreciate.
• Falling inflation works the other direction.
Influences on Balance of
Payments
• Change in Relative Investment
Prospects – affects capital account.
• Example: a country with good
investment prospects will attract foreign
investment and capital will flow in. The
increased demand for currency will
strengthen the exchange rate.
Influences on Balance of
Payments
• Change in Relative Interest Rates- impacts
short-term capital flows
• Example: and increase in the interest rate
will increase demand for bonds in that
country by foreigners. This will show up as a
capital inflow on the capital account, and a
strengthening of the exchange rate.
• Countries must be concerned with their
interest rates and the relative rates of other
countries.
Influences on Balance of
Payments
• Speculation – The capital account and
the exchange rate will be affected if
speculators believe there will be a
change in the exchange rate.
• Example: Speculators expect a
currency to appreciate, they will buy
quickly before it appreciates, causing it
to appreciate.
Influences on Balance of
Payments
• Use of Foreign Reserves- governments
using foreign reserves impact both the
balance of payments and the exchange rate.
• Example: If government aims to stabilize the
exchange rate it will buy or sell currency from
its foreign reserves. This item in the capital
account will decrease if the central bank is
buying, and increase if it is selling.
Balance of Payments, Aggregate
Demand and the Domestic
Economy
•
•
•
•
Remember, AD = C+I+G+(X-M)
Increase X = increase AD
Increase M = decrease AD
Therefore the Balance of Payments
influences the domestic economy.
• An increase in the BoP (X-M) will
increase National Income.
• A national income increase will either reduce
unemployment or increase inflation,
depending on how close the country is to full
employment.
• Conversely, a fall in the BoP (X-M) will reduce
National income and increase unemployment
or reduce inflation, depending on how close
to full employment level the country is.
So…let’s practice!