The Balance of Payments

Macroeconomic Theory I

ECON222

Fall 2017

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Main questions

How are saving and investment related to a countrys trade position?

What is the balance of payments account and what are its

determinants?

How is goods market equilibrium determined in an open economy?

How is Canadas real interest rate determined?

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Balance of payments

These accounts are the record of countrys international transactions

Transactions that yield a ow of funds into Canada are credit items

Transactions that yield a ow of funds out of Canada are debit items

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The current account (CA)

This account measures a countrys trade in currently produced

goods and services, plus net transfers between countries

The components of the current account balance are:

,! net export of goods and services (NX)
,! net investment income from assets abroad (NFP)
,! current transfers.

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The capital account (KA)

The capital and nancial account records trade in existing assets

There are two components:

,! the nancial account records direct and portfolio investment.
,! the capital account records migrantsfunds, inheritances,
transactions of intellectual property

If Canada sells an asset to another country it is a nancial inow for

Canada; a credit item (+) in the capital account.
If Canada buys an asset from abroad it is a nancial outow for
Canada; a debit item (-) in the capital account.

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The o cial settlements balance

This is the net increase (domestic less foreign) in a countrys o cial

reserve assets
,! gold, foreign government securities, foreign bank deposits and SDRs
at the IMF
,! assets used in international payments

The balance of payments can be in surplus or in decit

,! o cial reserve assets increase when there is a balance of payments
surplus.

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The current and capital accounts

At any point in time

CA + KA = 0

The statistical discrepancy represents a small dierence due to

measurement issues

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Net foreign assets and the balance of payments

Net foreign assets can change when:

,! the value of existing foreign assets and foreign liabilities changes, and
,! the country acquires new foreign assets or incurs new liabilities

The net amount of new foreign assets a country acquires is equal to

its current account surplus.

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Goods market clearing in an open economy

The open-economy goods market equilibrium condition is:

S d = I d + CA = I d + NX + NFP

,! desired national saving (S d ) must equal desired domestic investment

(I d ) plus the amount lent abroad CA

If NFP ' 0, then we can write this as:

Sd = I d + NX
d
NX = Y (C I d + G})
| +{z
absorption

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