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Chapter 35

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ECON 110
Ian James Cromb

Chapter 35 Exchange Rates and the Balance of Payments The Balance of PaymentsThe balance of payments account is a summary record of a countrys transactions with the rest of the world including the buying and selling of goods services and assetsTwo main categories to the balance of payments Current account and capital accountThe Current AccountThis is the part of the balance of payments accounts that records payments and receipts arising from trade in goods and services and from interest and dividends that are earned by capital owned in the country and invested in anotherThe current account is divided into two main sections o The trade account records the value of exports and imports of goods and servicesImports are debits exports are credits o The capitalservice account records the payments and receipts that represent income on assets like interest and dividendsPayments to foreigners are debits receipts are creditsThe Capital AccountThis part records payment and receipts arising from the purchase and sale of assets o The purchase of foreign assets is a debit capital outflow o The sale of assets to foreigners is a credit capital inflowDirect investment involves the purchasesale of assets that alter the legal control on those assets like controlling interest of a companyPortfolio investment involves transactions that do not alter the legal control of the assetsReserves are considered an asset rather than a goodservice and appear in this accountThe Balance of Payments must BalanceIn any period the Balance of PaymentsCurrent AccountCapital AccountZeroAny surplus on the current account must be matched by a deficit on the capital account o A current account surplus implies a capital outflowAny deficit in the current account must be matched by a surplus in the capital account o A current account deficit implies a capital inflowThe result of equaling zero is not an assumption about behaviour or any other reasoning o It is an accounting identityA Balance of Payments DeficitA balance of payments deficit probably refers to a situation in which the govt is selling official foreigncurrency reservesA balance of payments surplus refers to a situation in which the govt is buying official foreigncurrency reservesin both cases the actual balance of payments equals zero
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