Balance of payments
From Wikipedia, the free encyclopedia
The balance of payments (or BOP) measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year.
The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits).
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[edit] Components
The Balance of Payments for a country is the sum of the Current account, the Capital account, the Financial account, and the change in Official Reserves.
[Note: The "capital account" as is more properly now known as the financial account was renamed in the U.S. in 1999.][1]
[edit] Current account
The current account is the sum of net sales from trade in goods and services, net factor income (such as interest payments from abroad), and net unilateral transfers from abroad. Positive net sales from abroad corresponds to a current account surplus; negative net sales from abroad corresponds to a current account deficit. Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports.
The Income Account or Net Factor Income, a subaccount of the Current Account, is usually presented under the headings "Income Payments", as outflows, and "Income Receipts", as inflows. If the Income Account is negative, the country is paying more than it is taking in interest, dividends, etc. For example, the United States' net income has been declining exponentially since it allowed the Dollar's price relative to other currencies be determined by the market to a point where income payments and receipts are roughly equal. The various subcategories in the Income Account are linked to specific respective subcategories in the Financial account. From here, economists and central banks determine implied rates of return on the different types of capital exchanged in the Financial Account. The United States, for example, gleans a substantially larger rate of return from foreign capital than foreigners from domestic capital.
When analyzing the current account theoretically, it is often written as a function X of the real exchange rate, p, domestic GDP, Y, and foreign GDP, Y*. Thus the current account can be written as X(p, Y, Y*). According to theory, the current account X should increase if (1) the domestic currency depreciates (p increases), (2) domestic GDP decreases, or (3) foreign GDP increases. A domestic currency depreciation makes domestic goods relatively cheaper, boosting exports relative to imports. A decrease in domestic GDP reduces domestic demand for foreign goods, lowering imports without affecting exports. An increase in foreign GDP increases foreign demand for domestic goods, increasing exports without affecting imports.
Current account =
-
- Trade Balance
- Net Exports (Exports - Imports) of Merchandise (tangible goods)
- Net Exports (Exports - Imports) Services (such as legal and consulting services)
- + Net Factor Income From Abroad (such as interest and dividends)
- + Net Unilateral Transfers From Abroad (such as foreign aid, grants, gifts, etc.)
- Trade Balance
[edit] Capital Account
The capital account used to entitle the section now familiarly known as the financial account. This section usually includes special debt transactions between nations and migrants' goods as they cross a country's borders.
[edit] Official Reserves
The official reserve account records the government's current stock of reserves. Reserves include official gold reserves, foreign exchange reserves, and IMF Special Drawing Rights (SDRs). Reserve accounts typically are dominated by monetary authority intervention in the official currency's exchange rate.
Countries who try to control the price of their currency will have large net changes in their Official Reserve Accounts. Some of the most extreme examples include China and Japan. Japan in particular recently had a change in its reserves approximately one half of the entire net reported Balance of Payments. In 2003 and 2004, Japan had an outflow of reserves, yen, by more than equivalently one third of one trillion US Dollars.
In general, net increases in the Official Reserve Account will indicate that a country is buying its currency to try to keep the price dear from the perspective of whatever resource is being sold to acquire the currency. Countries with net decreases in the Official Reserve Account are usually attempting to keep the price of their currency cheap relative to whatever resource they are purchasing in exchange for the currency.
Some countries are much more difficult to detect in this regard. The United Kingdom is a good example. Its net changes in the Official Reserve Account are small, but this is because the monetary authorities of the UK borrow from one source, principally the IMF and its' SDR reserve, to buy back pounds in the form of bonds and money market accounts. This interesting example can be found in Section 7.9 in the Pink Book.
[edit] Financial account
The financial account is the net change in foreign ownership of domestic assets. If foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets in a given year, then the domestic country has a financial account surplus. On the other hand, if domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets, then the domestic country has a financial account deficit
The accounting entries in the financial account record the purchase and sale of domestic and foreign assets. These assets are divided into categories such as Foreign Direct Investment (FDI), Portfolio Investment (which includes trade in stocks and bonds), and Other Investment (which includes transactions in currency and bank deposits).
Financial account =
-
- Increase in foreign ownership of domestic assets
- - Increase of domestic ownership of foreign assets
[edit] Balance of Payments Identity
The Balance of Payments is the sum of the Current Account and the Capital Account. The Balance of Payments Identity states that:
- Current Account + Capital Account = Change in Official Reserve Account
Typically, in the United States, the change in official reserves in a given year is small relative to the Current Account and the Capital Account. Therefore it is sometimes approximated as zero. For example, if a government runs a current account deficit and has no change in official reserves, then the current account deficit must be balanced by a capital account surplus. The basic principle behind the identity is that a country can only consume more than it produces (a current account deficit) if it borrows from abroad (a capital account surplus). The United States has been carrying a negative current account balance for many years, and this debt has been primarily financed by issuing securities. This interpretation of the data, however, is disputed by Milton Friedman (Balance of Trade) claiming that cheaper, riskier, foreign capital is exchanged for "riskless", expensive, US capital and that the difference is made up with extra goods and services. Nevertheless, Friedman's interpretation is incomplete with respect to countries that interfere with the market prices of their currencies through the changes in their reserves.
A country will have a negative balance of payments (a net decrease in official reserves) if the net of the current account and the capital account is a deficit. Similarly, there will be a positive balance of payments (a net increase in official reserves) if the net of the current and the capital account results in a surplus.
[edit] Balance of Payments Equilibrium
A Balance of Payments Equilibrium is defined as a condition where the sum of debits and credits from the Current Account match the Financial Account; in other words, equilibrium is where
- Current Account - Financial Account = 0
This is a condition where there are no changes in Official Reserves.
[edit] History
Historically these flows simply were not carefully measured, and the flow proceeded in many commodities and currencies without restriction, clearing being a matter of judgement by individual banks and the governments that licensed them to operate. Mercantilism was a theory that took special notice of the balance in payments and sought simply to monopolize gold, in part to keep it out of the hands of potential military opponents (a large "war chest" being a prerequisite to start a war, whereupon much trade would be embargoed).
As mercantilism gave way to classical economics, these crude systems were later regulated in the 19th century by the gold standard which linked central banks by a convention to redeem "hard currency" in gold. After World War II this system was replaced by the Bretton Woods institutions (the International Monetary Fund and Bank for International Settlements) which pegged currency of participating nations to the US dollar, which was redeemable nominally in gold. In the 1970s this redemption ceased, leaving the system without a formal base. Some consider the system today to be based on oil, a universally desirable commodity due to the dependence of so much infrastructural capital on oil supply. Since OPEC prices oil in US dollars, the US dollar remains a reserve currency, but is increasingly challenged by the euro, and to a small degree the Japanese yen.
[edit] See also
- Current account
- Capital account
- Balance of trade
- List of countries and territories by current account balance
- International investment position
- Foreign exchange reserves
- Money supply
- United States public debt
- Pink Book
- Milton Friedman
[edit] References
- ^ Upcoming Changes in the Classification of Current and Capital Transactions in the U.S. International Accounts from BEA
[edit] External links
[edit] Data
- IMF DSBB
- United States DSBB (See "External Sector")
- BEA U.S. International Transactions Accounts Data
- BEA U.S. International Transactions Accounts Data Help
- Balance of Payments in Hong Kong
You can also download historical balance of payments information from 1960 under the "All Tables" link of the following page:
| Topics in Trade | |
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Definitions |
Balance of payments · Current account (Balance of trade) · Capital account · Foreign exchange reserves · Comparative advantage · Absolute advantage · Import substitution · International trade |
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Organizations & Policies |
World Trade Organization · International Monetary Fund · World Bank · International Trade Centre · Trade bloc · Free trade zone · Trade barrier · Import quota · Tariff |
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Schools of Thought |
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Related Issues |
