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Balance of Payments

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by

Ciaran Fitzpatrick

on 24 March 2014

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Transcript of Balance of Payments

Record of the value of all transactions between the residents of one country with the residents of all countries in the world over a given period of time.
Balance of Payments
Balance of Payments shows:
All payments received from other countries -
CREDITS
All payments made to other countries -
DEBITS
Balance of Payments
The goal of a country is to have the sum of inflows (CREDITS) equal the outflows to other countries (DEBITS).
Supply & Demand
for
Foreign Currency
When money flows into & out of a country it involves the exchange of National Currencies.
When you travel to USA, you change your Soles for US dollars.
You DEMAND US Dollars
&
SUPPLY Peruvian Soles
Residents of countries preferred to be paid in the currency of that country.
When you travel to the United States, do you pay in Soles? What do you do?
In a two-currency example:

Demand for Dollars --- Supply of Soles

Demand for Soles --- Supply of Dollars
The DEMAND for a foreign Currency ($$) generates a SUPPLY of Domestic Currency (Soles)
Balance of Payments:
All
CREDITS
(inflows of money into Peru) create a foreign DEMAND for Peruvian Soles.
All
DEBITS
(outflows of money from Peru) create a SUPPLY of Peruvian Currency.
How do Currency & the Balance of Payments relate?
Current Account
Capital Account
Two main parts to the Balance of Payments Account
Current Account:
The Balance of Trade in goods
The Balance of Trade in services
Net Income Flows
Net investment incomes
Net transfers of money
Also known as:
Visible balance
Merchandise Account balance
Balance of Trade
Balance of Trade
in Goods
If the calculation results in a Negative number
indicates a
DEFICIT on the Balance of Trade
Calculate by subtracting Imports
from
Exports
Positive Result
indicates
Surplus on the Balance of Trade
Also known as:
Invisible Balance
Services Balance
Net Services
Balance of Services
Exports:
When an International transaction leads to an inflow of money into the country.
Imports:
When an International transaction leads to an outflow of money.
Balance of Services:
Measure of revenue received from EXPORT of services MINUS the expenditure on the IMPORT of services.
Example:
A US tourist visiting Peru would be spending money that represents an INVISIBLE export to Peru(inflow of money)
&
An INVISIBLE import to the US economy(outflow of money)
Surplus & Deficits in terms
of
Currency
Deficit of an Account:
There is an excess quantity supplied in the foreign exchange market
Or
the sum of DEBITS is greater than CREDITS
Net Income
Flows
Two parts:
Net Investment Incomes
Net factor income from abroad
Net transfers of money
Current Transfers from abroad
Measure of the net monetary movement of profit, interest, and dividends into & out of the country as a result of financial investment abroad
Net Investment Income
Domestic firms that have set up branches in other countries & any profits brought back into the country will count as a positive item in the account.
Residents may have invested money in financial institution abroad & interest received in return will count as a positive item.
It also work the other way...
Any dividends or interest paid to foreign investors in other countries will count as a NEGATIVE against the account.
Payments made between countries when no items are exchanged.
Includes things such as foreign aid & grants
At an indivdual level it involves foreign workers sending money back to their families in their home countries
Net Transfers of Money
Note:
These accounts act independently of each other, and at any time, there may be a surplus or a deficit.
Measure of buying & selling of assets between countries.
Assets include:
Anything that can be owned - land, real estate, companies, bank deposits, stocks & shares. . .
Capital Account
In short, it measure the net change in foreign ownership of Domestic assets.
Foreign ownership of Domestic assets increases than Domestic ownership of Foreign assets.
More money is coming into the country therefore there is a Capital Account Surplus
If DOMESTIC ownership of Foreign assets increases more quickly than FOREIGN ownership of Domestic assets.
More money is leaving the country than coming in - Capital Account Deficit
Different classifications of Assets:
Ownership include buying property, businesses.
Expected to have a positive return in the future.
Investment does not have to be paid back
Buyer assumes the risk

Lending include T-bills, Gov't bonds, Savings accounts.
Investor is lending money to purchase the asset in expectation of interest paid on the investment.
Also, expect the investment to paid at a later date.
Balance of Payments
&
the meaning of "Balance"
Balance of Payments:
Sum of all Items is zero
Sum of all Credits is equal to Debits
Quantity of Domestic currency demanded is equal to Quantity of Domestic currency Supplied
Reasons for the "Balance":
Actions of the Central Bank
Buying & Selling Foreign Currency
Changes in the exchange rate
Reason for "surplus"& "deficit":
Excludes intervention from the Central Bank
Statistical Discrepancy:
Extremely difficult to record every transaction.
Some go unreported
If the payments do not balance, a residual item will be included to balance.
Makes Credits equal Debits
Country is consuming larger quantity of output than it is producing.

Pays for the extra output through a financial account surplus.
Current Account Deficit in Balance
of
Payments
A country whose imports are greater than its export:
Deficit on Current Account
Surplus on Financial Account
Provides foreign exchange necessary to pay for the excess of imports.
Surplus may arise from physical or financial capital by foreigners.
Loans from foreigners
A country who has more exports than imports:
Surplus in Current Account
Buying less from foreigners than it is selling to them.
Country producing on the PPC, consuming at a point within the PPC.
It is lending more to foreigners than it is borrowing
Buying more assets abroad than foreigners are buying

A surplus in the Current Account is roughly matched by a deficit in the Financial Account.
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