CHAPTER T H I R T E E N
13
International
Economics
Tenth Edition
Balance of Payments
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Introduction
 The balance of payments provides a summary
statement of international transactions for a
nation for a specified period of time.
 An international transaction is the exchange of a
good, service or asset between residents of one
nation and residents of another nation.
 The main purpose of the balance of payments is
to help the government in formulation monetary,
fiscal and trade policies.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The International Transactions of the United
States
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The International Transactions of the United
States
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Accounting Balances and the Balance of
Payments
 Current Account

All sales and purchases of currently produced
goods and services, investment incomes and
unilateral transfers, providing link between
international transactions and national
income.


Current account surplus stimulates domestic
production and income
Current account deficit dampens domestic
production and income
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Accounting Balances and the Balance of
Payments
 Capital Account

Includes debt forgiveness and goods and
financial assets that migrants take with them
as they leave or enter the country.

The U.S. deficit in the current and capital
accounts in 2007 are financed or covered by an
equal net inflow of capital abroad.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Accounting Balances and the Balance of
Payments
 Financial Account

Shows the change in U.S.-owned assets abroad
and foreign-owned assets in the United States.

The U.S. covers its current and capital account
deficits with an equal net financial account
surplus.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Accounting Balances and the Balance of
Payments
 If net private capital inflows do not cover the
current and capital accounts deficit, the nation has
a deficit in its balance of payments equal to the
difference, which needs to be covered by a net
credit balance on official (i.e., monetary authorities’)
reserve transactions.


Official settlements balance - The balance on official
reserve transactions, also called the balance of
payments.
Official reserve account – The account in which
official reserve transactions are entered.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Accounting Balances and the ex-ante Balance
of Payments
Current account balance
+ capital account balance
+ (‘spontaneous’) financial account
balance (excluding official reserve transactions, but including
net balance of financial derivatives)
+ statistical discrepancy
ex-ante Balance of Payments
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
 Ex-post BP is always ‘balanced’ or equal to
zero. There is no meaning in analyzing it.
 Ex-ante or spontaneous BP could be in
balanced (=0), or imbalanced being in surplus
(>0), or in deficit(<0).
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Accounting Balances and the ex-post Balance
of Payments
 Deficit in the ex-ante balance of payments
- covered ex-post by an
equal amount official reserves transaction
(reduction in international reserves of the nation
or increase in foreign holdings of official assets of
the nation).
(negative sum of account balances)
 Surplus in ex-ante the balance of payments
– settled ex-post by an
increase in the nation’s international reserves
and/or reduction in foreign official holdings of
nation’s assets.
(positive sum of account balances)
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Postwar Balance of Payments of the
United States
 Points to keep in mind when examining
balance of payments:
1.
Too much attention is usually placed on
balance of goods and short term data.

Dangerous to extrapolate for year based on
quarterly data.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Postwar Balance of Payments of the
United States
 Points to keep in mind when examining
balance of payments:
2.
International transactions are closely
interrelated rather than independent.

For example, cutting U.S. foreign aid programs
also reduces ability of recipients to import U.S.
goods, so improvement in U.S. balance of
payments may be much less than reduction in
aid.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Postwar Balance of Payments of the
United States
 Points to keep in mind when examining
balance of payments:
3.
An attempt to reduce the U.S. trade deficit
with respect to a nation such as Japan is
likely to reduce the U.S. surplus with respect
to Brazil because Brazil pays for U.S. goods
partly through natural resource exports to
Japan.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Postwar Balance of Payments of the
United States
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Postwar Balance of Payments of the
United States
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The International Investment Position of the
United States
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The International Investment Position of the
United States
 A nation’s BOP measures international flow
of goods, services and capital during a oneyear period (flow concept).
 A nation’s international investment position
measures total amount and distribution of
assets abroad and foreign assets in the nation
at the end of the year (stock concept).
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The International Investment Position of the
United States
 Also known as balance of international
indebtedness.
 Useful in projecting the future flow of income
from U.S. foreign investments and payments
on foreign investments in the U.S.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.