Final Balance of Payments

NATIONAL INCOME
GDP: National Spending = National Income Y=C+I+G+XM Y = GDP; C = Consumption; I = Physical Investment; G = Government Spending; X = Exports; M = Imports GNP NNP Current prices Constant prices
BALANCE OF PAYMENTS
WHY DO COUNTRIES TRADE?

Trade is simply buying and selling goods and services from other countries. Imports: The purchase of goods and services from foreign countries leading to outflow of currency. Export: The sale of goods and services leading to inflow of foreign currencies. But what really prompts countries to do these trades?

Different countries according to various factors have different levels of efficiency in producing different goods. Comparative Advantage

When a country can produce goods at lower opportunity cost i.e. it sacrifices less resources in production. When a country can produce goods with fewer resources than another country.
Absolute Advantage

A unit of labour can produce either 10 Good1 or 5 Good2 in country A, and a unit of labour in country B can produce either 20 Good1 or 40 Good2. Thus opportunity cost of producing additional Good2 is high in country A, and opportunity cost for producing Good1 is higher in country B.
Countries
Country A Country B Total
Good 1
5 10 15
Good 2
2.5 20 22.5
Now suppose the countries produce the goods in which they have minimum opportunity cost i.e. they achieve specialisation in the suitable good and then trade. Larger quantities will be produced and they will have mutual benefits. Below is Table for such production.(Lets suppose still Country B produces good 1 due to fear of shortage)
Countries
Country A Country B Total
Good 1
10 5 15
Good 2
0 30 30
INTRODUCTION ABOUT BOP

All modern economies prepare and publish this National Accounts. A record of all the factors, which create the demand for, and the supply of the countrys currency.
DEFINATION
The Balance of Payments of a country is a systematic accounting record of all economic transactions during a given period of time between the residents of the country and residents of foreign countries. The phrase residents of foreign countries may often be replaced by nonresidents, foreigners or rest of the world (ROW).
BALANCE OF PAYMENTS
A countrys balance of payments accounts keep track of both its payments to and its receipts from foreigners. Any transaction resulting in a payment to foreigners is entered in the balance of payments accounts as a debit and is given a negative () sign. Any transaction resulting in a receipt from foreigners is entered as a credit and is given a positive (+) sign.
WHAT IS ECONOMIC TRANSACTIONS?

By this we mean transfer of economic value from one economic agent (individual, business, government, etc.) to another. Something in return.
THE FOLLOWING BASIC TYPES OF

ECONOMIC TRANSACTIONS CAN BE IDENTIFIED:
1.
2.
3.
4. 5.
Purchase or sale of goods or services with a financial quid pro quo- or a promise to pay. One real and one financial transfer. Purchase or sale of goods or services in return for goods or services or a barter transaction. Two real transfers. An exchange of financial items e.g. purchase of foreign securities with payment in cash or by a cheque drawn on a foreign deposit. Two financial transfers. A unilateral gift in kind. One real transfer. A unilateral financial gift. One financial transfer.
COMPONENTS OF THE BALANCE OF PAYMENTS
(a) The Current Account: Under this are included imports and exports of goods and services and unilateral transfers of goods and services. (b) The Capital Account: Under this are grouped transactions leading to changes in foreign assets and liabilities of the country. (c) The Reserve Account:
THE CURRENT ACCOUNT
CONT.
Cr Dr Net
(b) Transfers 6 Official 7 Private (c) Income (i) Investment Income (ii) Compensation to Employees Total Current Account (I + II)
THE CAPITAL ACCOUNT
THE OTHER ACCOUNTS
STATISTICAL DISCREPANCY
Theres going to be some omissions and misrecorded transactionsso we use a plug figure to get things to balance. Exhibit 3.1 shows a discrepancy of $0.73 billion in 2000.
THE BALANCE OF PAYMENTS IDENTITY

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
U.S. BALANCE OF PAYMENTS DATA

Credits Current Account 1 2 3 Exports Imports Unilateral Transfers Balance on Current Account Capital Account 4 5 6 Direct Investment Portfolio Investment Other Investments Balance on Capital Account 7 Statistical Discrepancies Overall Balance Official Reserve Account $287.68 $474.39 $262.64 $444.26 0.73 $0.30 ($0.30) ($152.44) ($124.94) ($303.27) $10.24 $1,418.64 ($1,809.18) ($64.39) ($444.69) Debits

In 2000, the U.S. imported more than it exported, thus running a current account deficit of $444.69 billion.

During the same year, the U.S. attracted net investment of $444.26 billionclearly the rest of the world found the U.S. to be a good place to invest.

Under a pure flexible exchange rate regime, these numbers would balance each other out.

In the real world, there is a statistical discrepancy.

Including that, the balance of payments identity should hold:

BCA + BKA = BRA
($444.69) + $444.26 + $0.73 = $0.30= ($0.30)
BALANCE OF PAYMENTS AND THE EXCHANGE RATE

Exchange rate $
P S
D Q

Exchange rate $
P S
D Q
As U.S. citizens import, they are supply dollars to the FOREX market.

Exchange rate $
P S
S1
D Q
As the U.S. government sells dollars, the supply of dollars increases.
ACCOUNTING PRINCIPLES IN BALANCE OF PAYMENTS

One credit & One debit. Tt. of cr must match Tt. of dr.
CONT. RULE A
All transactions which lead to an immediate or prospective payment from the rest of the world (ROW) i.e. nonresidents, to the country in question i.e. residents of that country, should be recorded as credit entries in the BOP of that country and vice versa. A payment received from the ROW increases the countrys foreign assets - either the payment will be credited to a bank account held abroad by a resident entity or a claim is acquired on a foreign entity. Thus an increase in foreign assets (or a decrease in foreign liabilities) must appear as a debit entry
RULE B
A transaction which results in an increase in demand for foreign exchange or decrease in supply of foreign exchange is to be recorded as a debit entry (imports) while a transaction which results in an increase in the supply of (or decrease in demand for) foreign exchange is to be recorded as a credit entry.
Capital outflowe.g. when a resident purchases foreign securities or pays off a foreign bank loan uses up foreign exchange and hence is a debit entry while a capital inflow e.g. disbursement of loan by a foreign bank to a resident firm increases availability of foreign exchange and therefore is a credit entry.
BALANCE OF PAYMENTS
Case Study: Is the United States the Worlds Biggest Debtor? At the end of 1999, the United States had a negative 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 worlds largest GNP.

Final Balance of Payments

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Final Balance of Payments

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NATIONAL INCOME

WHY DO COUNTRIES TRADE?

WHY DO COUNTRIES TRADE?

WHY DO COUNTRIES TRADE?

WHY DO COUNTRIES TRADE?

INTRODUCTION ABOUT BOP

WHAT IS ECONOMIC TRANSACTIONS?

THE FOLLOWING BASIC TYPES OF

COMPONENTS OF THE BALANCE OF PAYMENTS

THE CURRENT ACCOUNT

THE CAPITAL ACCOUNT

THE OTHER ACCOUNTS

THE BALANCE OF PAYMENTS IDENTITY

Under a pure flexible exchange rate regime, BCA + BKA = 0

U.S. BALANCE OF PAYMENTS DATA

U.S. BALANCE OF PAYMENTS DATA

U.S. BALANCE OF PAYMENTS DATA

U.S. BALANCE OF PAYMENTS DATA

U.S. BALANCE OF PAYMENTS DATA

In the real world, there is a statistical discrepancy.

U.S. BALANCE OF PAYMENTS DATA

Including that, the balance of payments identity should hold:

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

BALANCE OF PAYMENTS AND THE EXCHANGE RATE

BALANCE OF PAYMENTS AND THE EXCHANGE RATE

BALANCE OF PAYMENTS AND THE EXCHANGE RATE

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

ACCOUNTING PRINCIPLES IN BALANCE OF PAYMENTS

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