4.6 Balance of payments

Balance of payments

Record of all financial transactions between residents of a country and the rest of the world

Consists of current account, capital account, and financial account

Credit item

Any transaction involving an inflow of funds

Recorded as a positive (+) in the balance of payments

Debit item

Any transaction involving an outflow of funds

Recorded as a negative (-) in the balance of payments

Current account

Includes trade in goods, services, income, and current transfers

Most important part is balance of trade in goods

Balance of trade in goods

Exports of goods minus imports of goods

Positive balance means surplus, negative means deficit

Balance of trade in services

Exports of services minus imports of services

Positive balance means surplus, negative means deficit

Income

Receipts from abroad minus payments abroad

Includes wages, interest, and profits

Current transfers

Transfers including remittances, pensions, and gifts

Receipts are credits, payments are debits

Capital account

Includes capital transfers and transactions in non-produced, non-financial assets

Usually less significant than financial account

Capital transfers

Includes debt forgiveness, migrant transfers

Inflows are credits, outflows are debits

Non-produced, non-financial assets

Includes rights to natural resources and patents

Purchases are debits, sales are credits

Financial account

Includes direct investment, portfolio investment, and reserve assets

Most important part is foreign investment flows

Direct investment

Investment in physical capital such as factories

Credits for inflows, debits for outflows

Portfolio investment

Investment in stocks and bonds

Credits for inflows, debits for outflows

Reserve assets

Central bank buying/selling foreign currency

Buying creates credit, selling creates debit

Errors and omissions

Statistical discrepancy to balance accounts

Used when items are missing or misreported

Balance of payments balance

Sum of current, capital, financial accounts, and errors and omissions

Always equals zero

Balance of payments and exchange rate

Exchange rate adjusts to make credits equal to debits

In floating systems, market forces do this automatically

Fixed exchange rate and balance

Government intervenes to create required credits or debits

May buy/sell currency or adjust interest rates

Current and financial account relationship

A surplus in one implies a deficit in the other because total balance must equal zero

Current account deficit

Puts downward pressure on the exchange rate

Results in exports increasing and imports decreasing

Current account surplus

Puts upward pressure on the exchange rate

Results in exports decreasing and imports increasing