APPENDIX TO
CHAPTER
16
Balance of Payments
GO ONLINE
The site www.stls.frb.org/
fred/data/exchange.html
contains exchange rates,
balance of payments,
and trade data.
Because international financial transactions such as foreign exchange interventions have considerable effect on monetary policy, it is worth knowing how these
transactions are measured. The balance of payments is a bookkeeping system
for recording all payments that have a direct bearing on the movement of funds
between a nation (private sector and government) and foreign countries.
The balance-of-payments account in the accompanying Following the
Financial News box uses a standard double-entry bookkeeping system much
like one that you or I might use to keep a record of payments and receipts. All
transactions involving payments from foreigners to Americans are entered in the
“Receipts” column with a plus sign (1) to reflect that they are credits; that is,
they result in a flow of funds to Americans. Receipts include foreign purchases
of American products such as computers and wheat (exports), purchases from
foreign tourists (services), income earned from American investment abroad
(investment income), foreign gifts and pensions paid to Americans (unilateral
transfers), and foreign payments for American assets(capital inflows).
All payments to foreigners are entered in the “Payments” column with a
minus sign (2) to reflect that they are debits because they result in flows of funds
to other countries. Payments include American purchases of foreign products
such as French wine and Japanese cars (imports), American travel abroad
(services), income earned by foreigners from investments in the United States
(investment income), foreign aid and gifts and pensions paid to foreigners
(unilateral transfers), and American payments for foreign assets (capital outflows).
Current Account
The current account shows international transactions that involve currently produced goods and services. The difference between merchandise exports (line 1)
and imports (line 2) is called the trade balance. When merchandise imports are
greater than exports (here by ⫺$838 billion), we have a trade balance deficit; if
exports are greater than imports, we have a trade balance surplus.
The next three items in the current account are the net payments or receipts
that arise from investment income, the purchase and sale of services, and unilateral
transfers (gifts, pensions, and foreign aid). In 2006, for example, net investment income
was positive $37 billion (in line 3) for the United States because Americans received
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Appendix to Chapter 16
FOLLOWING THE FINANCIAL NEWS
The Balance of Payments
Newspapers periodically report information on the balance of payments. Balance-of-trade figures (merchandise
exports minus imports) are reported monthly in the last week of the month. The complete set of items in the balance of payments is published on a quarterly basis, with the previous quarter’s figures published between the
eighteenth and twentieth day of the last month of the following quarter. An example of the balance-of-payments
accounts for the United States appears here.
U.S. Balance of Payments, 2009 ($ billions)
Receipts
(1)
Payments
(2)
Balance
Current Account
(1) Merchandise exports
⫹1,023
⫺1,861
(2) Merchandise imports
⫺838
Trade balance
(3) Net investment income
⫹37
(4) Net services
⫹80
⫺90
(5) Net unilateral transfers
Current account balance:
(1) ⫹ (2) ⫹ (3) ⫹ (4) ⫹ (5)
⫺811
Capital Account
⫺1,058
(6) Capital outflows
(7) Capital inflows
⫹1,444
⫺18
(8) Statistical discrepancy
Official reserve transactions balance:
(1) ⫹ (2) ⫹ (3) ⫹ (4) ⫹ (5) ⫹ (6) ⫹ (7) ⫹ (8)
⫺443
Method of Financing
(9) Increase in U.S. official reserve assets
(10) Decrease in foreign official reserve assets
Total financing of surplus: (9) ⫹ (10)
⫹3
⫹440
⫹443
Balance of Payments
Sum: (1) through (10)
Source: Survey of Current Business, www.bea.gov/scb/index.htm, International Data, tr06 F.2.
0
Balance of Payments
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more investment income from abroad than they paid out. Americans bought less in services from foreigners than foreigners bought from Americans, so net services generated $80 billion in receipts (line 4). Since Americans made more unilateral transfers
to foreign countries (especially foreign aid) than foreigners made to the United States,
a $90 billion payment is shown in line 5.
The sum of the items in lines 1 through 5 is the current account balance, which
in 2006 showed a deficit of $811 billion. The current account balance is an important balance-of-payments concept for several reasons. As we can see from the
balance-of-payments account, any surplus or deficit in the current account must
be balanced either by capital account transactions (lending or borrowing abroad)
or by changes in government reserve asset items:
Current account ⫹ capital account ⫽ change in government reserve assets
The current account balance tells us whether the United States (private sector
and government combined) is increasing or decreasing its claims on foreign wealth.
A surplus indicates that America is increasing its claims on foreign wealth, and a
deficit, as in 2006, indicates that the country is reducing its claims on foreign wealth.1
Financial analysts follow the current account balance closely because they
believe that it can provide information on the future movement of exchange rates.
The current account balance provides some indication of what is happening to the
demand for imports and exports, which, as we saw in Chapter 13, can affect the
exchange rate. In addition, the current account balance provides information about
what will be happening to U.S. claims on foreign wealth in the long run. Because a
movement of foreign wealth to American residents can affect the demand for dollar assets, changes in U.S. claims on foreign wealth, reflected in the current account
balance, can affect the exchange rate over time.2
Capital Account
The capital account describes the flow of capital between the United States
and other countries. Capital outflows are American purchases of foreign assets (a
“Payments” item), and capital inflows are foreign purchases of American assets
(a “Receipts” item). The capital outflows (line 6) are less than the capital inflows
(line 7), resulting in a net flow of $386 billion in funds from foreigners in exchange
for claims against American individuals and corporations.
1The
current account balance can also be viewed as showing by how much total saving exceeds private sector and government investment in the United States. We can see this by noting that total U.S.
saving equals the increase in total wealth held by the U.S. private sector and government. Total investment equals the increase in the U.S. capital stock (wealth physically in the United States). The difference between them is the increase in U.S. claims on foreign wealth.
2If American residents have a greater preference for dollar assets than foreigners do, a movement
of foreign wealth to American residents when there is a balance-of-payments surplus will increase the
demand for dollar assets over time and will cause the dollar to appreciate.
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Appendix to Chapter 16
The statistical discrepancy (line 8) represents errors due to unrecorded transactions involving smuggling and other capital flows. The statistical discrepancy, which
keeps the balance-of-payments account in balance, is ⫺$18 billion, which suggests
that some of the other items in the balance of payments may not be measured very
accurately. Many experts believe that the statistical discrepancy is primarily the result
of large hidden capital flows, and so the item has been placed in the capital account
part of the balance of payments.
Official Reserve Transactions Balance
The sum of lines 1 through 8, called the official reserve transactions balance, equals
the current account balance plus the items in the capital account. When we refer
to a surplus or a deficit in the balance of payments, we actually mean a surplus or
deficit in the official reserve transactions balance. Because the balance-of-payments
account must balance, the official reserve transactions balance tells us the net amount
of international reserves that must move between central banks to finance international transactions. One reason we are particularly interested in the movements of
international reserves is that, as we saw earlier in the chapter, these movements
can have an important impact on the money supply and exchange rates.
Methods of Financing the Balance
of Payments
Because most countries’ currencies are not held by other countries as international
reserves, these countries must finance an excess of payments over receipts (a deficit
in the balance of payments) by providing international reserves to foreign governments
and central banks. A balance-of-payments deficit is associated with a loss of international reserves; likewise, a balance-of-payments surplus is associated with a gain.
In contrast to other countries’ currencies, the U.S. dollar and dollar-denominated
assets are the major component of international reserves held by other countries.
Thus a U.S. balance-of-payments deficit can be financed by a decrease in U.S. international reserves, an increase in foreign central banks’ holdings of international
reserves (dollar assets), or both. Conversely, a U.S. balance-of-payments surplus can
be financed by an increase in U.S. international reserves, a decrease in foreign central banks’ international reserves, or both.
For the United States in 2006, the official reserve transactions deficit of ⫺$440 billion was financed by a $443 billion increase in U.S. international reserves (⫹3 in the
“Receipts” column of line 9) and a $440 billion increase of foreign holdings of dollars
(in the “Receipts” column of line 10).3 On net, the United States’ indebtedness to foreign governments (central banks) increased by $443 billion (the $440 billion foreign
increase in holdings of U.S. dollars plus the $3 billion increase in U.S. holdings of international reserves). This $440 billion increase in net U.S. government indebtedness
just matches the $440 billion official reserve transactions surplus, so the sum of lines
1 through 10 is zero, and the account balances.
3
At first it may seem strange that when the United States gains $1 billion of international reserves, it is
entered in the balance of payments as a payment with a negative sign. Recall, however, that when a central
bank gains international reserves, it has purchased foreign assets. Thus an increase in international reserves
is just like an outflow of capital in the capital account and appears as a payment with a negative sign.