Lecture Slides Chapter 10

BALANCE OF PAYMENTS

Chapter 10

BALANCE OF PAYMENTSo definition – record of exchange of goods,

services or assets between businesses, individuals, and governments of one country with the rest of the world

o credit – receipt of payment from foreign source• merchandise exports• transportation & travel receipts• gifts from foreign residents• investment in U.S. by foreign residents

o debit – payment to foreign source• merchandise imports• transportation & travel expenditures• gifts to foreign residents• foreign investment by U.S. residents• aid given by U.S. government

CURRENT ACCOUNTo definition – monetary value of transactions in

goods, services, income flows and unilateral transfers

o merchandise trade balance – includes all goods that U.S. exports or importso surplus (positive balance) implies exports > importso deficit (negative balance) implies imports > exports

o goods and services balance – services added to merchandise trade balance

o unilateral transfers – gifts of goods & services or financial assets between the U.S. and the rest of the world

CAPITAL AND FINANCIAL ACCOUNTo definition – international purchases & sales of

real estate, stocks & bonds, government securities and commercial bank deposits

o examples:• direct investment – residents of one country acquire

10% or more of business in another country• securities – private sector purchases • bank claims – loans, overseas deposits,

acceptances, foreign commercial paper• bank liabilities – demand deposits, NOW accounts,

savings deposits, CDso official settlements transactions – movement

of financial assets among official holders such as the Fed and Bank of England

OFFICIAL RESERVE ASSETS

purposes:o international liquidity to finance short run trade

deficits and weather periodic currency criseso provide ability to buy or sell reserve assets in

private markets in order to stabilize exchange rates

U.S. BALANCE OF PAYMENTS - 2008

(amounts in billions)

U.S. BALANCE OF PAYMENTS: 1980-2008

(amounts in billions)

o trade deficits can decrease value of dollar decreasing U.S. purchasing power abroad

o trade deficits can also decrease employment in domestic industries but are offset by capital inflows generating employment in other industries

NET FOREIGN INVESTMENT AND THE CURRENT ACCOUNT BALANCEo current account surplus => excess of exports

over imports => net supplier of funds => improves net foreign investment position

o current account deficit => excess of imports over exports => net demander of funds => decline in net foreign investment position

o net borrowing:

(G - T) + (I – S) = Current Account Government Private Private Deficit

Deficit Investment Saving (net borrowing)

IS CURRENT ACCOUNT DEFICIT A PROBLEM?o A current account deficit has little to do with

inherent inability of a country to sell goods in world market.

o Rather, such a deficit indicates imports were needed to meet the domestic demand for goods and services.

o Current account deficits are not reversed by trade policies that attempt to alter the levels of import or exports.

o Resulting debt is less problematic if funds are used for investment spending rather than consumption spending.

CURRENT ACCOUNT & ECONOMIC GROWTHo short run: recession => current account surplus

• savings falls but investment falls to a greater degree• imports tend to fall with the decrease in overall

demando long run: rapid

economic growth leads to current account deficits because of investment financed via foreign saving

CONTINUOUS CURRENT ACCOUNT DEFICIT?o no economic reason why current account deficit

cannot continue indefinitelyo deficits from 1820-1875 as other nations

invested in the U.S.o dependent on foreign willingness to invest in the

U.S.o current account

could be decreased through foreign growth and increased national savings

GLOBAL SAVINGS GLUT?o excess global savings allowed U.S. borrowing

• corporate profits in Japan• savings greater than investment in China• oil profits in the Middle East and Russiao surge in savings lowered interest rates which

lead to investments that were unproductive and reduction of Fed’s control of economy

o U.S. absorbed an estimated 75% of excess world savings in 2006

o concern: reduction in such investment in the U.S. will cause significant depreciation in the dollar and a substantial increase in interest rates

U.S. AS DEBTOR NATIONo net creditor – U.S. claims on foreigners exceed

foreign claims on U.S.o net debtor – foreign claims on U.S. exceed U.S.

claims on foreigners

o reasons U.S. is net debtor: foreign investors placed more funds in the U.S. because of economic growth and political stability