IB Economics/International Economics/Balance of payments

4.5.1 Current Account


 * External equilibrium is concerned with the Balance of Payments: An account of the transactions between domestic and foreign economies.
 * The current account includes the trade account which records the goods and services imported and exported from the home country.
 * A deficit on the trade account means that imports are larger than exports.
 * Those items which lead to Europeans receiving money from abroad are counted as positive items in the balance of payments.
 * A more technical definition: those items which lead to more Euros being purchased are counted as a positive item on the Balance of Payments.
 * The current account:
 * Records all international transactions involving goods and services.

The Balance of Trade
 * Merchandise account: also called the visible account in Britain, which records all transactions involving goods.
 * The Traded Service account which records all transactions involving services.
 * The Capital Servicing account:
 * Includes the interest, profits and dividends paid to and by foreigners.
 * For developing countries, this section is usually negative. More is paid out to foreign investors than is received as interest and dividends.
 * For industrialized countries like the US and Japan, this account is typically positive because of the large amount earned on foreign investments.

Invisible Balance 4.5.2 Capital Account
 * Consists of the Capital Servicing account plus the Traded Services account.


 * The capital account records financial transactions involving short term and long term capital movements into and out of the country.
 * When financial capital flows into a country, that country is exporting a security to the foreigner.
 * The security can consist of a money market instrument, a bond, a stock or a joint venture agreement or some kind of contractual arrangement.
 * When those securities are exported, financial capital flows into the domestic economy and counts as a plus in the Balance of payments.

This is how the balance of payments is always balanced: if there are negatives on the current account, they must be balanced by a plus on the capital account. Official Reserves
 * Capital account: if the Japanese invest in US treasury bills, it is the US that gets the money, and the Japanese that get the TB's.
 * It counts as negative on the Japanese balance of payments (and their GDP).
 * Short term capital is held mainly in money market instruments such as treasury bills or bank accounts (portfolio as opposed to direct investment).
 * Long term capital movements:
 * Portfolio: generally involve the purchase of stocks or bonds.
 * Direct: investments in capital in the country or joint venture agreements.
 * As an alternative to short term and long term, the Capital account is divided by:
 * Direct investments: which includes direct investment in a branch plant or a subsidiary for a large multinational company or a joint venture agreement
 * Portfolio investments: which includes transactions involving securities such as money market instruments or stocks and bonds.
 * If we include official reserves, the balance of payments is always in balance.
 * One of the easiest ways to think about it is to ask who gets the money.
 * Current account: if Japan imports apples from China, the Chinese get the money, the Japanese get the apples. It counts as a minus in the Japanese balance of payments (and for the GDP).
 * If the Chinese buy cars from Japan, the Chinese get the cars and the Japanese get the money: a plus on Japan’s balance of payments.
 * For services: if the Japanese go skiing in Switzerland, the Swiss get the money, and the Japanese get the tourism experience. It enters as a negative on the Japanese balance of payments.


 * Factors influencing the balance of payments include:
 * Income: as national income rises the demand for imports rise shifting the current account toward a deficit.
 * Changes in relative prices: as domestic prices rise relative to foreign prices, imports appear cheaper and exports more expensive and the current account will move toward a deficit.
 * Changes in relative investment prospects: as return on investment rises, foreign capital will be attracted into the country and the capital account will move toward a surplus.
 * Changes in relative interest rates: as domestic interest rates rise, short term capital is attracted moving the capital account toward a surplus.


 * If the foreign exchange rate is rising (domestic currency appreciating), the central bank may intervene by selling more domestic currency.
 * If the foreign exchange rate is falling (domestic currency is depreciating), the central bank may intervene by buying domestic currency with the reserve of foreign currency.