Final Balance of Payments (2)

7/30/2019 Final Balance of Payments (2)

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NATIONAL INCOME

GDP: National Spending = National Income

Y = C + I + G + X M

Y = GDP; C = Consumption; I = PhysicalInvestment; G = Government Spending; X =

Exports; M = Imports GNP

NNP

Current prices

Constant prices


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BALANCE OF PAYMENTS


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WHYDO COUNTRIES TRADE?

Trade is simply buying and selling goods andservices from other countries.

Imports: The purchase of goods and services fromforeign countries leading to outflow of currency.

Export: The sale of goods and services leading toinflow of foreign currencies.

But what really prompts countries to do thesetrades?


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Different countries according to various factors havedifferent levels of efficiency in producing differentgoods.

Comparative Advantage

When a country can produce goods at lower opportunitycost i.e. it sacrifices less resources in production.

Absolute Advantage

When a country can produce goods with fewer resources

than another country.


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Countries Good 1 Good 2

Country A 5 2.5

Country B 10 20

Total 15 22.5

A unit of labour can produce either 10 Good1 or 5Good2 in country A, and a unit of labour in countryB can produce either 20 Good1 or 40 Good2.

Thus opportunity cost of producing additional

Good2 is high in country A, and opportunity cost forproducing Good1 is higher in country B.


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Countries Good 1 Good 2

Country A 10 0

Country B 5 30

Total 15 30

Now suppose the countries produce the goods in whichthey have minimum opportunity cost i.e. they achievespecialisation in the suitable good and then trade.

Larger quantities will be produced and they will havemutual benefits.

Below is Table for such production.(Lets suppose stillCountry B produces good 1 due to fear of shortage)


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INTRODUCTIONABOUT BOP

All modern economies prepare and publish thisNational Accounts.

A record of all the factors, which create the demandfor, and the supply of the countrys currency.


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DEFINATION

The Balance of Payments of a country is asystematic accounting record of all economictransactions during a given period of time betweenthe residents of the country and residents of foreign

countries.

The phrase residents of foreign countriesmay often be replaced by nonresidents,foreigners orrest of the world (ROW).


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BALANCE OF PAYMENTS

A countrys balance of payments accounts keeptrack of both its payments to and its receipts fromforeigners.

Any transaction resulting in a payment to foreignersis entered in the balance of payments accounts asa debit and is given a negative () sign.

Any transaction resulting in a receipt fromforeigners is entered as a credit and is given a

positive (+) sign.


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WHATISECONOMICTRANSACTIONS?

By this we mean transfer of economic value fromone economic agent (individual, business,government, etc.) to another.

Something in return.


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THEFOLLOWINGBASICTYPESOFECONOMICTRANSACTIONSCANBEIDENTIFIED:

1. Purchase or sale of goods or services with afinancial quid pro quo- or a promise to pay. Onereal and one financial transfer.

2. Purchase or sale of goods or services in return for

goods or services or a barter transaction. Tworeal transfers.

3. An exchange of financial items e.g. purchase offoreign securities with payment in cash or by acheque drawn on a foreign deposit. Two financialtransfers.

4. A unilateral gift in kind. One real transfer.

5. A unilateral financial gift. One financial transfer.


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COMPONENTS OF THEBALANCE OF PAYMENTS

(a) The Current Account: Under this are includedimports and exports of goods and services andunilateral transfers of goods and services.

(b) The Capital Account: Under this are groupedtransactions leading to changes in foreign assetsand liabilities of the country.

(c) The Reserve Account:


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THECURRENTACCOUNT


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CONT.

Cr Dr Net

(b) Transfers6 Official7 Private

(c) Income(i) Investment Income(ii) Compensation to Employees

Total Current Account (I + II)


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THE CAPITAL ACCOUNT


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THE OTHER ACCOUNTS


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STATISTICAL DISCREPANCY

Theres going to be some omissions andmisrecorded transactionsso we use a plugfigure to get things to balance.

Exhibit 3.1 shows a discrepancy of $0.73 billion in2000.


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THE BALANCEOF PAYMENTSIDENTITY

BCA + BKA + BRA = 0

where

BCA = balance on current account

BKA = balance on capital account

BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0


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U.S. BALANCEOF PAYMENTS DATA

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)

3 Unilateral Transfers $10.24 ($64.39)

Balance on Current Account ($444.69)

Capital Account

4 Direct Investment $287.68 ($152.44)

5 Portfolio Investment $474.39 ($124.94)

6 Other Investments $262.64 ($303.27)

Balance on Capital Account $444.26

7 Statistical Discrepancies

Overall Balance $0.30

Official Reserve Account ($0.30)

0.73


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In 2000, the U.S.

imported more than it

exported, thus running

a current accountdeficit of $444.69

billion.

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73


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During the same year,

the U.S. attracted net

investment of $444.26

billionclearly the rest

of the world found theU.S. to be a good place

to invest.

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73


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Under a pure flexible

exchange rate regime,

these numbers would

balance each other

out.

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73


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In the real world,

there is a statistical

discrepancy.

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73


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Including that, the

balance of payments

identity should hold:

BCA + BKA =BRA

($444.69) + $444.26+ $0.73 = $0.30=

($0.30)

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73


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BALANCEOF PAYMENTSANDTHE EXCHANGE RATE

Q

P

Exchange rate $Credits DebitsCurrent Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73

S

D


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Q

P

As U.S. citizens import, they are supply dollars to the FOREX market.

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73

Exchange rate $

S

D


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Q

P S

D

As the U.S. government sells dollars, the supply of dollars increases.

S1

Credits Debits

Current Account

1 Exports $1,418.64

2 Imports ($1,809.18)



Capital Account








0.73

Exchange rate $


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ACCOUNTING PRINCIPLESIN BALANCE OF PAYMENTS

One credit & One debit.

Tt. of cr must match Tt. of dr.


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CONT. RULE A

All transactions which lead to an immediate orprospective payment from the rest of the world(ROW) i.e. nonresidents, to the country in questioni.e. residents of that country, should be recorded as

credit entries in the BOP of that country and viceversa.

A payment received from the ROW increases thecountrys foreign assets - either the payment will becredited to a bank account held abroad by a

resident entity or a claim is acquired on a foreignentity. Thus an increase in foreign assets (or adecrease in foreign liabilities) must appear as adebit entry


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RULE B

A transaction which results in an increase indemand for foreign exchange or decrease in supplyof foreign exchange is to be recorded as a debitentry (imports)

while a transaction which results in an increase inthe supply of (or decrease in demand for) foreignexchange is to be recorded as a credit entry.


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Capital outflowe.g. when a resident purchasesforeign securities or pays off a foreign bank loanuses up foreign exchange and hence is a debitentry while a capital inflow e.g. disbursement of

loan by a foreign bank to a resident firm increasesavailability of foreign exchange and therefore is acredit entry.


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BALANCE OF PAYMENTS

Case Study: Is the United States the Worlds

Biggest Debtor?

At the end of 1999, the United States had anegative net foreign wealth position far greater

than that of any other single country.

The United States is the worlds biggest debtor.

However, the United States has the worldslargest GNP.

Documents

Final Balance of Payments (2)