Lecture 9
THE BALANCE OF PAYMENTS ACCOUNTS

It is the statistical record of all economic transactions taking place between a country's residents and the rest of the world.

• Current account   [trade in goods and services]
• Capital account   [trade in assets by the private sector]
• Official reserves account   [foreign-exchange transactions by central banks]

a. Sign (+ or -) of entry

Credit (+): If transaction results in receipts from foreigners
Debit (-): If transaction results in payment to foreigners

Every international transaction enters the balance of payments accounts twice (a credit and a debit).

(a) Merchandise trade:

• Exports and imports of goods

• Tourism (expenditures by German tourists in Florida)
• Transportation (freight and insurance charges)
• Professional and other services (Management consulting fees, royalties, copyright fees)

• Payments for the services of capital "working" abroad
• Interest payments and dividends

• Government grants (foreign aid)
• Private remittances
  • From emigrant workers to families
• Pensions to retired people living abroad

(a) Foreign direct investment (FDI)

• A country's residents acquire control over a foreign firm:
  • Buy enough stock (10%)
  • Take over the firm outright
• Build a new factory

• Short-term
  • Maturity of 1 year or less
  • Checking accounts in foreign banks
  • Certificates of deposit in foreign banks
• Long-term
  • Maturity greater than 1 year
  • Stocks and bonds of foreign corporations

• Increase in foreign ownership of U.S. assets
• Decrease in U.S. ownership of foreign assets

Central bank transactions in international reserve assets:

• Gold
• Foreign exchange reserves ($, €, ¥)
• SDR's [Asset created by the IMF; value based on $, €, ¥, £, RMB]

• Increase in foreign reserve assets held in the U.S.
• Decline in the Fed's foreign-exchange reserves

Example 1: If ORT = $60 bn for Bank of China, it means that the Chinese central bank is selling $60 bn worth forex reserves.

Example 2: If ORT = -$20 bn for the Reserve Bank of India, it means that the Indian central bank is buying $20 bn worth forex reserves.

6. Official settlements balance or Balance of payments

• The sum of the current account and the capital account
• If the balance of payments is positive, the central bank is gaining foreign-exchange reserves

• Measurement errors in trade data
• Incorrect valuation of transactions
• Fraud: Some transactions may not be reported

CA = current a/c balance
KA = capital a/c balance
ORT = official reserve transactions
SD = statistical discrepancy
BP = balance of payments (Official settlements balance)

(1)     CA + KA + ORT + SD = 0
(2)     BP = CA + KA + SD
(3)     ORT = -BP

Questions

1. If the balance of payments is positive (a surplus) in a year, has there been an increase, or a decrease in the stock of official reserve assets? [Hint: Use eq (3).]
2. Assume that the statistical discrepancy is zero. If a country's current account is in deficit, and private foreign investors do not buy any of the country's assets, is the central bank selling, or buying, foreign-exchange reserves?