The balance of payments

The Balance of Payments The Balance of Payment • The 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 time – Private transactions (individuals and business firms) – Official transactions (government transactions) Economic Transaction • Any 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 country – Debit: Are those transactions that would mean a loss of foreign exchange The Balance of Payment • Table 12.1 provides an example of the historic detailed balance of payments for the United States • Simplified US balance of Payments for 2000 Simplified US Balance of Payments for 2000 (billions $) Credits Debits Net Merchandise 772 1224 -452 Services 292 218 74 Income 353 331 22 Unilateral transfers -53 Current Account -410 US-owned assets abroad -606 Foreign-owned assets 1015 Capital Account Statistical Discrepancy 409 Current account • Includes the value of trade in merchandise, services, income, and unilateral transfers • Figure 12.1 shows change in balance of payments over time • Current account excludes capital account transactions – purchases and sales of financial assets United States Current Account Balance (1960-98) 100000 50000 Millions $ -50000 1960 1970 1980 1990 1998 -100000 -150000 -200000 -250000 -300000 Balance on current account Balance on services Balance on Merchandise Trade Balance on income Financing Current Account: • Large current account deficit means large capital account surplus • Important items included in the capital account: – – – – – Direct Investment Security purchases Bank claims and liabilities U.S government assets abroad Foreign official assets in the United States Capital Account • One 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 National Savings, Investment and Current Account • Y=C+I+G+X – Where: • • • • • Y = National income C= Consumption spending I = Investment spending G=Government spending X=Net export or the current account National Savings, Investment and Current Account • Rearranging the above equation: • Y-C-G=I+X=S • Where S = national saving – The 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 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 The World’s Largest Debtor • September 10, 1985 US became a debtor nation • In 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 surpluses • On 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 The World’s Largest Debtor • To consume more at home then is produced, the US must borrow from abroad • US borrowed at high level • Large reduction in US foreign lending • US federal budget deficits made lending at home more attractive 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 fall • Capital account surplus will equal to falling current account deficit • US will become a net lender Additional Summary Measures • Balance-of-merchandise trade • Official settlements balance is the value of the change in financial assets held by foreign monetary agencies and official reserve asset transactions 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 bank 2)US firm sells $1 million worth of wheat to the Romanian firm The wheat is paid with the bank account created in transaction 3)US resident receives $10,000 in interest from German bonds she owned The $10,000 is deposited in a German bank 4) A US tourist travels to Europe and spends the $10,000 German deposit Balance of Payments Credit (+) Merchandise Net Bal $1 mil (2) Services Income Debit (-) 10,000 (4) 10,000(3) Unilateral transfers Current account $+1 mil Official capital Private capital $1 mil (1) 10,000 (4) $1 mil (1) $1 mil (2) 10,000 (3) Totals $2,020,000 $2,020,000 Balance of Payments Equilibrium and Adjustment • Economic implications of the balance of payments • Global 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 A • Balance of payments equilibrium – exports equal imports or credits equal debits for a particular account (current account or official settlements account) Balance of Payments Equilibrium and Adjustment • Current account equilibrium for a nation would mean unchanging net creditor or debtor position, no need for net financing • Equilibrium on official settlements would mean no change in our financial assets held by foreign monetary agencies and reserve assets Balance of Payments Equilibrium and Adjustment • There is a disequilibrium in the balance of payments, in official settlements part • Deficit countries will experience reserve asset losses and surplus countries – reserve accumulation • International reserve assets are composed of gold, IMF special drawing rights, and foreign exchange • Lets consider change in international reserve assets based on foreign exchange along Balance of Payments Equilibrium and Adjustment • British pound is worth 1.50 US dollars • Supply-demand for foreign exchange market • Demand for pounds comes from US demand for British goods or financial assets • Supply of pounds comes from British buyers of US goods or financial assets • Upward sloping supply curve implies that as pound appreiciates in value US products are cheaper to Br Buyers, more pounds supplied to this market Balance of Payments Equilibrium and Adjustment • Equilibrium is restored at the new equil Point • Flexible exchange rates - free market supply and demand determines the value of currencies • Fixed exchange rates –central banks set exchange rates at desired levels • Developing countries use direct controls on international trade to shift supply/demand curves ... mean a loss of foreign exchange The Balance of Payment • Table 12.1 provides an example of the historic detailed balance of payments for the United States • Simplified US balance of Payments for.. .The Balance of Payment • The 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. .. 10,000 (3) Totals $2,020,000 $2,020,000 Balance of Payments Equilibrium and Adjustment • Economic implications of the balance of payments • Global current account balance has summed to deficit in recent