Balance of Payments

Definition: Summary statement of financial transactions between

one nation and all other nations during a 1 year period.
(U.S. and some other developed nations provide the
information quarterly)

General principles:
1. Only a few major categories are used (all transactions are made
to fit in these categories)
2. Only the net balance is shown
3. Some transactions that are shown do not involve foreigners –
for example the central bank (FED) sells foreign currency to
commercial banks.
 BOP (continued)

Definitions:
• International Transaction: exchange of good, service, or asset for
which payment is usually required (gifts and other transfers are
also included in this definition).
• Residents include:
1. Diplomats, military, tourists and temporary workers
2. A corporation is a resident of the country within which it is
incorporated.
• Foreign branches and subsidiaries of corporations are
not considered residents.
 BOP (continued

BOP Accounting Principles:

• Credit Transactions: transactions that involve the receipt of

payments from foreigners [+ sign]

Examples:
1. Export of goods and services.
2. Unilateral transfers received from foreigners.
3. Capital inflows.
• An increase in foreign assets in the nation
• A reduction in a nations assets held abroad
 BOP (continued

Debit Transactions: Transactions that involve the making of

payments to foreigners. [- sign]

Debit Examples:
1. The importation of goods and services.
2. Unilateral transfers to foreigners.
3. Capital outflows
• An increase in a nations assets abroad.
• A reduction of foreign assets in the nation.
Troublesome Concepts

Capital inflows
• An increase in foreign assets in the nation
• A reduction in a nation’s assets held abroad

Capital outflows
• An increase in a nation’s assets abroad.
• A reduction of foreign assets in the nation.
 Balance of Payments (examples)
Action: The U.S. exports $500 or merchandise to be paid for in 3 months.

Name of Account Credit (+) Debit (-)

Goods Exports + 500

Capital Outflow -500

 Balance of Payments (examples)
Action: U.S. resident visits London and spends $200 on hotels, meals, etc.

Name of Account Credit (+) Debit (-)

Travel Services Purchased from -200

Foreigners

Capital inflow +200

 Balance of Payments (examples)
Action: The U.S. Government gives U.S. bank balance of $100 to a developing
nation (part of a U.S. aid program).

Name of Account Credit (+) Debit (-)

Unilateral Transfer -100

Capital inflow +100

 Balance of Payments (examples)
Action: a U.S. resident purchases a foreign stock for $400 and pays for it by
increasing foreign bank balances in the U.S.

Name of Account Credit (+) Debit (-)

Capital outflow: an increase in -400

U.S. owned assets abroad

Capital inflow: an increase in +400

foreign owned assets in the U.S.
 Balance of Payments (examples)
Action: a foreign investor buys $300 of Treasury Bills by drawing down bank
balances in the U.S.

Name of Account Credit (+) Debit (-)

Capital inflow: an increase in foreign + 300

owned assets in the U.S.

Capital Outflow: a reduction of -300

foreign owned assets in the U.S.
 Resulting BOP From the 5 Previous Transactions

Name of Account Credit (+) Debit (-)

Goods 500

Services 200

Unilateral Transfers 100

Capital 200

Total 500 500

 Explanation of Various Balances

•Balance on Goods Trade: Just the net of imported and exported

goods

•Balance on Services: Just the net balance of the services account

•Balance on Goods and Services: Net balance of the above two

accounts
•Balance on Income: net balance of income from assets abroad and
income payments to foreign assets held within the domestic
country
•Balance on goods, services and income: Net balance of the
above three accounts
 Explanation of Various Balances (continued)
• Unilateral Current Transfers Net: Just the net of unilateral
transfers
• Balance on all the above = Current Account Balance
• Current Account Balance = net balance of
1. Goods
2. Services
3. Income
4. Unilateral transfers

Current Account Surplus = stimulus for domestic production and

income
Current Account Deficit = drain on domestic production and income

Remember (Xprts-Mports) from your macro principles class!

 Capital Account:
•The net change in U.S. owned assets abroad and foreign assets
in the U.S. [Excluding official reserve assets because they
reflect government policy]

Autonomous Transactions: All transactions in current and capital

accounts [also known as items “above the line”]

Accommodating Transactions: transactions in official reserve assets

[also known as items “below the line”]
These may be needed to balance international transactions
This is known as the “official reserve account”—the balance of
this account is know as the official settlements balance
 Official Settlements Balance

Total debits > total credits [in the current and capital accounts
• The net debit balance measures the deficit in the nations
BOP: This debit must be “settled” with an equal net
credit in the “official reserve account”

a deficit in the BOP is measured either as

1. An excess of debits over credits in the current and capital
accounts, or
2. An excess of credits over debits in the official reserve account
 Official Settlements Balance (continued)

a deficit in the BOP is measured either as

1. An excess of credits over debits in the current and capital
accounts, or
2. An excess of debits over credits in the official reserve
account

These explanations are strictly correct only under a fixed exchange

rate system [1945-1973]. They are not strictly correct under a
flexible or managed exchange rate system like we now use (but they
are close).