FUNDAMENTALS OF BUSINESS ECONOMICS

C.  Balance of Payments Fundamentals

• Balance of payments - summary of all transactions between residents of one nation and the residents of the rest of the world during a given time period

- Transactions

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- Between residents

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- During a given period of time

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1.  Parts of the balance of payments

• U.S. balance of payments

a.  Current account

(1)  Goods and services

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(2)  Net income

• Compensation received by domestic residents from foreign companies - income paid to foreign residents by domestic companies

• Investment returns received by domestic residents from foreign companies - investment returns paid by domestic companies to foreign residents

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(3)  Net current transfers

• International gifts and aid received by domestic residents - amounts paid to foreign residents

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b.  Financial / capital account

(1)  Direct investments

• Assets that have lasting interests in foreign countries

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(2)  Portfolio investments

• International debt and equity instruments

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(3)  Financial derivatives

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(4)  Other investments

• Trade credits, loans, changes in bank deposits

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(5)  Capital account

• Transactions related to international debt forgiveness

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(6)  Net errors and omissions

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c.  Reserves account

• Summary of changes in a nation's official international reserves

• Foreign currency, commodities (gold and other precious metals), borrowing rights (from IMF and other organizations)

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2.  Balance of payments measures

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a.  Trade Balance (Merchandise Trade Balance)

• Import and export of merchandise

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b.  Balance on goods and services

• Add import and exports of services

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c.  Balance on goods, services, and incomes

• Add net income earned from or paid to foreign residents

• International investments, rentals, and wages

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d.  Current account

• Add net flows from transfers of international gifts, aid, and donations

• Current account deficits financed with surpluses in the rest of balance of payments

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• Current account deficit => "living beyond means"

• Whether a deficit is good or bad depends on what is done with money

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e.  Overall balance

• Compares current account with financial / capital account

• Equal to and opposite of reserves account

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(1) Overall balance surplus and the foreign exchange market

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(2)  Overall balance deficit and the foreign exchange market

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3.  Macroeconomic implications

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