Section 2 – Balance of

Payments
• Section 2.1. Balance of Payments.

• Balance of Payments (BoP) accounts and their connection with

national income statistics.
• Shed light on monetary policy, domestic and international and
macroeconomic policies.

• Suppose a country faces the BoP statement

Category Net Exports (Exports minus Imports)
Goods 100
Currency -100
Total 0
• Net exports are positive.

• More was exported than imported. Ex-Imp > 0

• 100 units of currency were accumulated.

• Suppose now that there are financial claims and currency.

Category Net Exports
Goods and Services 100
Financial Claims -80
Currency -20
Total 0
• In this case both goods and services are included in the BoP account.

• Currency increased by 20 units.

• However, money accrued from exports over imports were invested in

financial assets in the rest of the world.

• There is thus a claim of -80 against the rest of the world.

• The following definitions are stated.

Net Exports of BoP Concept

Goods and Services Balance on Current Account
Financial Claims Balance on Capital Account
International Reserves -Balance on Official Reserve
Transactions

• The Current Account Balance refers to the net exports of goods and
services.
• Capital Account Balance refers to the net export of financial claims.
• The Balance on Official Reserve Transactions is equal to the sum of
the previous two.
Net Exports of 1965 1970 1975 1980 1985 1990
Goods and Services 5.4 2.3 18.1 2.3 -123.9 91.9
(Current Account Balance)
Financial Claims -6.7 -11.7 -24.3 -9.7 128.8 59.8
(Capital Account Balance)
International Reserves 1.3 9.4 6.2 7.3 -5.0 32.0
(-Official Reserve Transactions Balance)

1965 1970 1975 1980 1985 1990

Net Exports of:
Goods and Services 5.4 2.3 18.1 2.3 -123.9 91.9
Financial Claims -6.7 -11.7 -24.3 -9.7 128.8 59.8
Net Import of:
International Reserves -1.3 -9.4 -6.2 -7.3 5.0 -32.0
• Section 2.2. BoP and National Income Identities.

• How do the BoP accounts relate to the national income identities?

• For a closed economy (exports and imports are zero)

Y = C+I+G (2.1)

• Y is total production which is equivalent to total income.

• C is consumption.
• I is investment.
• G is government expenditure.
• In an open economy the goods and services include imports denoted
IM.
• Production or income for domestic use is increased by the amount of
exports denoted EX

Y+IM = C+I+G+EX (2.2)

• Let Net Exports be X = EX-IM

Y = C+I+G+X (2.3)
• In (2.3) X is the net export of goods and services.
• This is taken as equal to the Current Account.

Current Account = Net Export of Goods and Services

+Net Unilateral Transfers+Net Receipt of Interest

(2.4)

• (2.4) is approximate.
• Discrepancies are statistical anomalies.
Year Net Exports of Net Investment Net Unilateral Balance on Current
Goods and Services, Income Transfers Account
BoP Accounts
1965 4.7 5.3 -4.6 5.4
1970 2.3 6.2 -6.2 2.3
1975 12.4 12.8 -7.1 18.1
1980 -19.4 30.1 -8.3 2.3
1985 -122.1 21.2 -22.9 -123.9
1990 -78.4 20.3 -33.8 -91.9
• Net Exports closely approximate BoP.

• Relate X to saving and investment.

• Private (households and firms) Saving is defined as after-tax income

minus consumption

(2.5)
• Government saving is the negative of the government budget deficit.

(2.6)

• The sum of (2.5) and (2.6) is National Saving.

(2.7)

• Using (2.3) in (2.7) yields

(2.8)
• National Saving is equal to domestic (I) and foreign (X) investment.

• X is net foreign investment as it is approximately equal to the Current

Account Balance.

• The Current Account Balance is in turn equal to the net import of

reserves or other financial claims on the rest of the world.
• Rearranging (2.5)

(2.9)

• Using (2.9) and (2.3) yields

(2.10)

• Private saving less domestic investment equals the government deficit

plus the current-account (BoP) surplus.
• Thus if were determined autonomously, i.e. did not respond to fiscal
policy actions, then any change in the government budget deficit
would be offset by an equal magnitude change in the current account
BoP deficit.