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Topic 4: Balance of payments and exchange
rates
Page references are to the basic course text ECONOMICS by Paul A. Samuelson and William D.
Nordhaus 19th Edition International Edition 2010
Balance of payments (international payments)
“A statement showing all of a nation’s transactions with the rest of the world for a given period. It includes purchases and sales of goods and services, gifts, government transactions, and capital movements” (SN, 2010, p. 655)
Flows versus stocks
“A flow variable is one that has a time dimension or flows over time (like the flow through a stream) A stock variable is one that measures a quantity at a point of time (like the water in a lake)...” (SN, 2010, p. 662).
Income and payments, credits and debits, assets and liabilities
“Debit: … In balance-of-payments accounting, a debit is an item such as imports that reduces a country’s stock of foreign currencies” (SN, 2010, p. 658). (“Debits” refer back to “Payments” in accounting balance).
“Credit: … In balance-of-payments accounting, a debit is an item such as exports that earns a country a foreign currency” (SN, 2010, p. 658). (“Credits” refer back to “Income” in the accounting balance).
“Asset. A physical property or intangible right that has economic value. Important examples are plant, equipment, land, patents, copyrights, and financial instruments such as money or bonds. (SN, 2010, p. 654). (See also the concept of “financial account”.)
“Liabilities. In accounting, debts or financial obligations owed to other firms or persons” (SN, 2010, p. 666).
Deficit, Surplus
According to the dictionary of the Real Academia Española, a surplus is “in trade, the excess of assets or wealth over the debits or obligations of the cash balance” (i.e. the excess of assets- income over debits- Payments). The opposite is a deficit. To summarise, calculating (above the line of changes in reserves and in the combination of lines for each case) if the difference between Income (I) and payments (P) i.e. I-P shows a positive balance, there is a surplus. If it is a negative balance there is a deficit.
Trade balance (see Balance of Trade)
Exports and imports of goods.
Balance of Trade. “ That part of a nation’s balance of payments that deals with imports or exports of goods, including such items as oil, capital goods and automobiles... (SN, 2010, p. 655).
Balance on current account or Current account balance
A balance formed by the items relating to goods, services, income (of factors) and current account transfers.” In balance-of-payments accounting, the current account is financed by the financial account”. (SN, 2010, p. 655).
Net foreign Investment
“Net foreign Investment: Net saving by a country abroad: approximately equal to net exports”. (SN, 2010, p. 669).
“Net exports: In the national product accounts, the value of exports of goods and services minus the value of imports of goods and services.” (SN, 2010, p. 669).
Capital account
This includes capital transfers and the acquisition and disposal (purchase and sale, not use) of non-financial non-produced assets (physically speaking) such as patents and brands (these two are intangible assets), land, amongst others, which similar to the “use” of factors- labour and capital- are not accounted for in the capital balance- the former being recorded in “services” and the latter being recorded in “income”).
Capacity or financing requirement/necessity
Combined balance on current account and the capital balance. If it is positive (Income greater than payments, surplus) and in the opposite case (I-P is negative, deficit).
Financial account
Includes all the liabilities (in the column for income) and the financial assets (in the column for payments).
“ Financial assets. Monetary claims or obligations by one party against another party. Examples are bonds, mortgages, bank loans, and equities” (SN, 2010, p. 6621).
“Financial assets” form part of total “assets” (“Asset. A physical property or intangible right that has an economic value. Important examples are plant, equipment, land, patents, copyrights, and financial instruments such as money or bonds”, SN, 2010, p. 654) as opposed to “tangible assets” (“Tangible assets. Those assets, such as land or capital goods like computer, buildings, and automobiles that are used to produce further goods and services.”(SN, 2010, p. 674).
Reserves and changes in reserves
International reserves which all nations maintain, at least in the form of gold, foreign currencies and special drawing rights (SDRs). International reserves serve as “international money” which can be used when a country experiences difficulties with its balance of payments. If a nation is willing to let its exchange rate fluctuate freely, it would need minimum reserves.
Reserves are not recorded in the balance of payments because they are a stock. However changes in reserves are recorded since they are a variable flow associated with reserves.
The balance of payments balance
This equals all income less payments above the line of changes in reserves. If it is positive (surplus) it indicates an accumulation of reserves (the inflow is greater than the outflow). In the opposite case (deficit) reserves are lost.
Foreign currency and the foreign exchange market
“The market in which currencies of different countries are traded.”(SN, 2010, p. 662).
