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Balance of Payments - Lecture Notes
International Finance (Ec3012)
City University London
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Balance of Payments
• Balance of Payments: record of all economic transactions between the
residents of the country in question and the rest of the world during a given period of time (usually 1 year)
• Reveals:
- volume of goods and services imported and exported
- Whether the country in question has been borrowing from or lending to the
rest of the world
- Changes in the quantity of reserves of foreign currency held by the central
bank
• Residents = individuals, households, firms and public authorities
• BoP includes transactions between the residents of the country in question and
residents of the rest of the world.
• BoP statistics: based on samples
• Presentation of BoP statistics vary from country to country.
• IMF: Provides guidelines for the compilation of BoP statistics published in BoP
manual.
• IMF publishes BoP statistics for all country members in a standarized format.
• BoP is based on the principle of double- entry bookkeeping
• Receipt of currency from residents of the rest of the world: credit
• Each payment to residents of the rest of the world: debit (-)
BOP:
A) Current account: income flows B) Capital Account: assets and liabilities
Trade Balance
• Difference between receipts for exports of goods and expenditure on imports of
goods which can be visibly seen crossing frontiers.
Current Account Balance
• Sum of “visible” trade balance and “invisible” trade balance
• “invisible” = difference between revenue received for exports of services and
payments made for import of services,
- receipts and payments of interest dividends and profits
- Unilateral payments and receipts: no quid pro quo ex: Pension payments to
foreign residents, which will be recorded as debit by the country of origin
Capital Account Balance
Sum of “visible” trade balance and “invisible” trade balance
Records movements of financial capital in and out of the country.
Capital inflows (credit items):
- Foreign borrowing
- Sales of overseas assets
- Investment in the country by foreigners
Official Settlement Balance
Summation of current account balance, capital account balance and the statistical discrepancy (omissions and errors).
Importance: it shows money available for adding to country’s official reserves or paying off country’s official borrowing.
Reserve increases are recorded as a (-) because given a surplus, the currency appreciates and CB buys reserves (-) to ensure balance.
Bop surplus/deficit
Autonomous receipts greater than autonomous payments: surplus
Autonomous receipts smaller than autonomous payments: deficit
Accommodating items: transactions which finance any difference between autonomous receipts and payments
Basic Balance
Current account balance + net balance on long- term capital flows. (Stable elements of the BoP)
Overall basic balance deficit is not necessarily a bad thing. ex.: capital outflow yields future profits.
- Overall basic balance surplus is not necessarily a good thing. Ex: current account deficit and capital account surplus through loans, as interests will be payable in the future.
Official Settlements Balance
Operations by money authorities to finance any imbalance in the current and capital accounts.
Accommodating items: only relevant to countries with fixed exchange rates
In difference form (first derivative)
The government expenditure multiplier
Shows the increase in national income resulting from an increase in government expenditure.
Government spending will have an expansionary effect on national income which will be determined by s and m.
Since s + m < 1, the resulting increase in national income Y will be greater than the increase in G
The export multiplier
The multiplier effect of an increase in exports on national income is identical to that of an increase in government expenditure
Vertical axis: injections/ leakages
Horizontal axis: income
S+M increase as income rises.
Equilibrium of national income: determined where investments + exports (injections) equal savings and imports (leakages) Y 1
Increase in X or G results in (G + I + X) 1 shifting to (G + I + X) 2 and the rise in income induces more savings and import expenditure.
Overall, the increase Y 1 Y 2 is greater than the increase in injections.
The lower s and m, the flatter S+M and the greater the increase in income when (G + I + X) moves upwards.
Equation 2.
Equation 2.
The current account multipliers
dCA/dG = - m/(s+m) < 0
An increase in government spending leads to a deterioration of the current account balance.
Effect of an increase in exports on the current balance:
dCA/dX= 1 — m/(s + m) = (s+m)/(s+m) — m/(s+m)
- = s/(s+m) > 0
s/(s+m) < 1
An increase in exports improves the current balance in less than the original increase in exports.
The effect of an increase in exports is offset by an increase in imports.
Balance of Payments - Lecture Notes
Module: International Finance (Ec3012)
University: City University London
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