Overview

 

This chapter begins thediscussion of international finance and macroeconomics—the subject of PartsThree and Four of the book. Its major purpose is to show how the balance ofpayments accounts for international transactions and how the different balances(or sub-balances) can be interpreted. It also presents the internationalinvestment position.

 

A country's balance of paymentsrecords all economic transactions between the residents of the country andresidents of the rest of the world. Each transaction or exchange results in twoopposite flows of value. By convention, a credit or positive item is the flowfor which the country is paid—it is the item that the country gives up in thetransaction, and it sets up a claim on the foreign resident, so that funds (or"money") flow into the country. A debit or negative item is the flowthat the country must pay for—it is the item that the country receives in thetransaction, and it sets up a foreign claim on a resident of the country, sothat funds (or "money") flow out of the country.

 

Each transaction has both acredit and a debit item—double-entry bookkeeping—at least once we create afictional "goodwill" item for things that are given away (unilateralor unrequited transfers). Therefore, if we add up all items for the country'sbalance of payments, it must add up to zero. What we find interesting about thebalance of payments is not that it must completely add up to zero, but ratherhow it does so. What are the values of different categories of items?

 

Typically, the first categorieswe examine are items that are international flows of goods (or merchandise),services, income, and gifts—the current account. Services include flows oftransportation, financial services, education, consulting, and so forth. Incomeincludes flows of  payments such asinterest, dividends, and profits. In addition to the full current accountbalance, we can also examine the goods and services balance.

The (private) financial accountincludes items that are nonofficial international flows of financial assets.(Note that we use the name “financial account,” following the recently adoptedstandard terminology, in place of the traditional name “capital account.”)Financial capital inflows are credit items—capital or funds flow into the countryas the country "exports" financial assets (by increasing liabilitiesto foreigners or decreasing assets previously obtained from foreigners).Financial capital outflows are debit items—capital or funds flow out of thecountry as the country "imports" financial assets (by increasing thecountry's assets obtained from foreigners or decreasing its liabilities toforeigners). Direct investments are international capital flows between unitsof a company located in different countries (Chapter 15 has a detaileddiscussion of foreign direct investment and multinational firms). If theinvestor does not have management control, international investments in stocksand bonds are usually called international portfolio investments. Cross-borderloans and bank deposits are other capital flows included in the financialaccount.

 

The third and final major part ofthe country's balance of payments records official international flows offinancial assets that serve as official international reserves. The country'smonetary authority (usually, its central bank) undertakes these transactions.Official international reserves include financial assets denominated in readilyaccepted foreign currencies, the country's holdings of Special Drawing Rights(SDRs), the country's reserve position at the International Monetary Fund(IMF), and gold.

 

If all items are recordedcorrectly, the sum of all of these items equal zero. In practice, they are notand do not, so that a line called "statistical discrepancy" is addedto make the accounts add to zero. It represents the net of many items that aremismeasured or missed (net errors and omissions).

 

The current account balance (CA)has several meanings. First, CA equals the value of the country's net flow (I_f)of foreign investments (both private and official). Second, CA equals thedifference between national saving and domestic real investment (S - I_d). Third, because CA isapproximately equal to the difference (X - M) between the value of thecountry's exports of goods and services and the value of its imports of goodsand services, CA is (approximately) equal to the difference between domesticproduction of goods and services and national expenditures on goods andservices (Y - E). The text shows how the current accountand goods and services balances have changed over time for four countries—theUnited States, Canada, Japan, and Mexico.

The overall balance shouldindicate whether a country's balance of payments has achieved an overallpattern that is sustainable over time. While there is no perfect indicator ofoverall balance, we often examine the country's official settlements balance(B), which is the sum (CA + FA) of the current account balance and the privatefinancial account balance (including the statistical discrepancy). The officialsettlements balance also equals the (negative of the) official reserves balance(OR). Most of the official reserves flows indicate official intervention by themonetary authorities in the foreign exchange market.

 

The international investmentposition is a statement of the stocks of a country's foreign assets and foreignliabilities at a point in time. The text shows that theUnited Stateshas changed from being an international debtor to creditor and back to a debtorduring the past century.