The document discusses balance of payments categories and the international flow of goods, services, and capital. It describes how the current account, capital account, and official reserves account relate through double-entry bookkeeping. It also explains the linkages between domestic savings and investment, and the current and capital accounts. The document considers possible solutions for coping with a current account deficit, finding that currency depreciation and protectionism are generally ineffective, while stimulating national saving may help address imbalances.

1. CHAPTER 5
The Balance of
Payments and
International Economic
Linkages

2. PART I. BALANCE-OF-PAYMENT
CATEGORIES
A. THE BALANCE OF PAYMENTS
(B-O-P)
1. PURPOSE:
Measures all financial and economic
transactions over a specified period
of time.

3. BALANCE-OF-PAYMENT
CATEGORIES
2. Double-entry bookkeeping
a. Currency inflows = credits earn
foreign exchange
b. Currency outflows = debits expend
foreign exchange

4. BALANCE-OF-PAYMENT
CATEGORIES
3. Three Major Accounts:
a. Current
b. Capital
c. Official Reserves
4. Current Account
records net flow of goods, services,
and unilateral transfers.

5. BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account
a. Function: records public and private
investment and lending.
b. Inflows = credits
c. Outflows = debits

6. BALANCE-OF-PAYMENT
CATEGORIES
5. Capital Account (con’t)
d. Transactions classified as
1.) portfolio
2.) direct
3.) short term

7. BALANCE-OF-PAYMENT
CATEGORIES
6. Official Reserves Account
a. Function:
1.) measures changes in
international reserves owned by
central banks.
2.) reflects surplus/deficit of
a.) current account
b.) capital account

8. BALANCE-OF-PAYMENT
CATEGORIES
6. Official Reserves Account (con’t)
b. Reserves consist of
1.) gold
2.) convertible securities

9. BALANCE-OF-PAYMENT
CATEGORIES
7. Net Effects:
a. Sum of all transactions must be
zero:
1.) current account
2.) capital account
3.) official reserves

10. BALANCE-OF-PAYMENT
CATEGORIES
8. The Balance-of-payment measures
a. Some Definitions:
1.) Basic Balance
a.) consists of current
account and long-term
capital flows.

11. BALANCE-OF-PAYMENT
CATEGORIES
1.) Basic Balance (con’t)
b.) emphasizes long-term trends.

12. BALANCE-OF-PAYMENT
CATEGORIES
1.) Basic Balance (con’t)
c.) excludes short-term capital flows that
heavily depend on temporary factors.

13. BALANCE-OF-PAYMENT
CATEGORIES
2.) Net Liquidity Balance:
measures the change in private
domestic borrowing or lending
require to keep payments equal
without adjusting official reserves.

14. BALANCE-OF-PAYMENT
CATEGORIES
3.) Official Reserve Transactions
Balance
- measures adjustments needed by
official reserves.

15. PART II. THE INTERNATIONAL
FLOW OF GOODS, SERVICES,
AND CAPITAL
II. LINKS FROM INTERNATIONAL
TO DOMESTIC FLOWS
A. Global Linkages
set of basic macroeconomic identities which
link: domestic spending and production to
current and capital accounts

16. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
B. Domestic Savings and Investment
and the Capital Account
1. National Income Accounting
a. National Income (NI) is either spent
(C) or saved (S)
NI = C + S (5.1)

17. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
b. National spending (NS) is
divided into personal spending (C)
and investment (I)
NS = C + I (5.2)

18. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
c. Subtracting (4.2) - (4.1)
NI - NS = S - I (5.3)
If NI >NS, S > I which implies that surplus
capital spent overseas.

19. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
d. In a freely-floating system,
excess saving = the capital
account balance
e. Implications:
1. A nation which produces more
than it spends will save more
than it invests domestically
with a net capital outflow
producing a capital account
deficit.

20. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
2. A nation which spends more than it
produces has a net capital inflow
producing a capital account surplus.
3. A healthy economy will tend to
run a current account deficit.

21. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
C. THE LINK BETWEEN THE
CURRENT AND CAPITAL
ACCOUNTS
1. Beginning identity
NI - NS = X - M (5.4)
where X = exports
M = imports
X-M=current account balance
(CA)

22. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
2. Combining (5.3) + (5.4)
S - I = X - M (5.5)
3. If S - I = Net Foreign Investment
(NFI)
NFI = X - M (5.6)

23. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
4. Implications:
a. If CA is in surplus, the nation must be
a net exporter of capital.
b. If CA is a deficit, the nation is a major
capital importer.
c. When NS > NI, the excess must be
acquired through foreign trade.

24. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
d. Solutions for Improving CA deficits:
1.) Raise national income (output)
relative to domestic investment (I).
2.) Increase (S) relative to domestic
investment (I).

25. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
D. GOVERNMENT BUDGETS
AND CURRENT ACCOUNT
DEFICITS
1. CURRENT ACCOUNT BALANCE
CA = Saving Surplus - Gov’t budget
deficit

26. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
2. CA Deficit means
the nation is not saving enough to
finance (I) and the deficit.
3. CA Surplus means
the nation is saving more than needed
to finance its (I) and deficit.

27. PART III. COPING WITH THE
CURRENT ACCOUNT DEFICIT
I. POSSIBLE SOLUTIONS
UNLIKELY TO WORK:
A. Currency Depreciation
B. Protectionism

28. COPING WITH THE CURRENT
ACCOUNT DEFICIT
II.CURRENCY DEPRECIATION
A. U.S. Experience:
Does not improve the trade deficit.

29. COPING WITH THE CURRENT
ACCOUNT DEFICIT
B. Depreciations are ineffective because
1. It takes time to affect trade.
2. J-Curve Effect
states that a decline in currency
value will initially worsen the deficit
before improvement.

30. THE J - CURVE
TIME
Net
change
in trade
balance
0
Currency
depreciation
Trade balance
initially deteriorates
Trade balance
improves

31. COPING WITH THE CURRENT
ACCOUNT DEFICIT
III. PROTECTIONISM
A. Trade Barriers used:
1. Tariffs
2. Quotas
B. Results:
Most likely will reduce both X and M.

32. COPING WITH THE CURRENT
ACCOUNT DEFICIT
C. FOREIGN OWNERSHIP
one protectionist solution would place
limits on or eliminate foreign ownership
leading to capital inflows.

33. COPING WITH THE CURRENT
ACCOUNT DEFICIT
D. STIMULATE NATIONAL
SAVING
change the tax regulations and rates.

34. COPING WITH THE CURRENT
ACCOUNT DEFICIT
III. SUMMARY: CURRENT-ACCOUNT
DEFICITS
- neither bad nor good inherently
1. Since one country’s exports are
another’s imports, it is not
possible for all to run a surplus

35. COPING WITH THE CURRENT
ACCOUNT DEFICIT
2. Deficits may be a solution to the problem
of different national propensities to save
and invest.