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Balance of payments. Looking at the flow of money in and out of countries around the world. Flow of money. - PowerPoint PPT Presentation
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Balance of payments
Looking at the flow of money in and out of countries around
the world
Flow of money
Money is constantly flowing around the world as people, businesses and government transact
business with other countries. People travel, goods are imported and exported, investments
are made….
The balance of payments records the
transactions between residents of a country and the residents of all other countries.
Credits show money coming in to the country while debits show money leaving the country.
By definition, the sum of credits and debits always equals zero
Balance of payments
Obviously different countries have different currencies. If a Canadian travels to India, she must exchange her Canadian dollars for Indian rupees in the foreign exchange market. She
demands Indian rupees and supplies Canadian dollars within the foreign exchange market.
The foreign exchange market facilitates financial transactions among people,
businesses and governments as they interact with other countries.
Foreign Exchange
When trading one currency for another, the
demand for a particular foreign currency generates a supply of the domestic currency (and vice versa). So all money coming into India (credits) must originate with a demand
for rupees, while all money leaving India (debits) must begin with a supply of rupees to
buy a foreign currency.
Supply and demand
A country’s balance of payments is presented
in chart or table form with three main categories. These categories are:
The current account
The capital account
The financial account
Balance of payments
The current account lists exports of a country
(credit) as well as imports to the country (debit) for both goods and services. If a country’s exports of goods and services
exceed their imports, then they will have a surplus on its balance on goods and services. Additionally, net income and net transfers are listed in the current account. A country like
the USA has a negative current account balance (deficit) because its imports greatly
exceed its exports.
Current Account
For a country like the USA with a deficit in its
current account, more dollars are supplied in the foreign exchange market than dollars are
demanded. So the sum of debits is larger than the sum of credits.
The trade balance is the largest of all the categories within the current account, so a
country like China would have a surplus in its current account because it is a net exporter.
Current Account
The capital account shows the net flow of funds for the purchase of assets such as land
or natural resources. This is not a large part of the balance of payment equation, and may be
either positive or negative.
Capital Account
The financial account shows the net flow of
funds into and out of the country in the form of assets, foreign investments and loans to or from other countries. A country like the USA has a positive balance in its financial account
as it receives more funds from foreign countries in the form of investments and purchases of USA physical capital, than
Americans invest abroad.
Financial Account
The USA has a surplus in its financial account
meaning that credits exceed debits and the quantity of dollars demanded exceeds the
quantity of dollars supplied. Therefore there is an excess of US dollars demanded in the
foreign exchange market.
Financial Account
The moral of the story is that for every country
the value of the current account will be offset by the value of the capital account plus the
value of the financial account, which is why its called the balance of payments.
The quantity of domestic currency demanded will be equal to the quantity of domestic
currency supplied for two reasons…..
Balance of Payments
Reason 1—A country’s central bank can buy
and sell foreign currency to create a balance of payments
Reason 2—Changes in exchange rates can also create a balance of payments
Balance of Payments
If for some reason there isn’t exact equality
between the current account and the combined capital account and financial
account, an entry called statistical discrepancy will be listed to ensure that a
balance of payments is arrived at.
This will create a situation where the credits and debits are equal to zero
Statistical Discrepancies
A country like the USA which is a net importer
therefore has a deficit in its current account. It is enjoying a level of consumption beyond
its PPC. The USA must have a surplus in its financial
account therefore to achieve its balance of payments, which may come from foreign
investments in the USA or loans made to the USA by foreign countries.
Another perspective
A country like China which has a surplus in its
current account balance because it is a net exporter is consuming beneath its PPC.
China, by selling so many exports, has a vast amount of foreign currency which it uses to
buy foreign assets or to make loans to foreign countries. Therefore China has a negative
financial account balance leading to its balance of payments.
Yet another perspective