Chapter 13 – Balance of Payments, Debt, Financial Crises, and Stabilization Policies
• How debt would be implemented in the economy, how external debt has an effect on
developing countries’ economies
The Balance of Payments Account
• BofP summary of a nations and its residents financial transactions with the rest of the
world. Comprised of:
o Current account focuses on export and import of goods and services, investment
income, debt service payments and private and public new remittances and
transfers
▪ flow of funds that go to the country and outside the country. Ex: import
and export. Also investment income is a good example, debt service also
how much debt the countries have
▪ Current Account – Financial Account – Official Reserve Transactions = 0
▪ CA deficit: CA < 0 → Country borrows from the rest of the world or
reduces cash position.
• when you add current account – capital account – cash account = 0
• If less than 0 = deficit
• If more than 0 = surplus
▪ CA surplus: CA > 0 → Country lends to the rest of the world or increases
cash position.
• On average, better to have a current account surplus & an
increasing net asset position.
• “BoP deficit” refers to “Current Account – Financial Account” and
its impact on Official Reserves
o If we’re missing money and are in deficit overall, the
country needs to go and take money into their cash
account.
o Capital account records the value of private foreign direct investment, foreign
loans by private banks and multilateral agencies minus capital outflow. Look at
value of actual capital goods
o Official reserve transactions by the central bank (cash account) including foreign
hard currency, gold, deposits with the IMF
A Schematic Balance of Payments Account
• Net remittances: Transfers that came into the countries from various purposes and what
came out of the countries. Ex: earn a wage somewhere else than your countries and
when come back, use that money to contribute in your economy (negative)
• Direct private investment: private investment made into the country either by individuals
and firms
• Foreign loans, minus amortization: amount you need to repay, already have is the
amortization.
• Resident capital outflow: lot of the time when financial crisis = capital flies where capital
runs away of the country
• Cash reserve account: we have our total current account either going to be a surplus of
deficit. once you had them up together and have a negative balance, what happens?
Example of a Transaction
• Every complete economic transaction is recorded twice (like accounting)
• Example: Argentina’s BoP Account
o Argentina exports wheat to Germany in exchange for tractors (recording inflow
and outflows)
o Credit for the wheat and debit for the tractors import appear on the merchandise
trade account
Credits and Debits in the Balance of Payments Account
A Hypothetical Balance of Payments Table for a Developing Nation
Net Financial Transfers of Developing Countries, 1978-1990 (billions of dollars)
• A huge portion of that deficit results in capital flies.
• What can the government do to ….?
o Implement tariff and limit imports, devalue their currency
Financing and Reducing Payments Deficits
• International reserves can decline if there is a BofP deficit.
• Policy options in the face of a BofP deficit
• Promote export expansion
• Limit imports (through quotas, tariffs, import substitution)
• Currency devaluation
• Encourage more FDI or portfolio flows
• Borrow from international commercial banks (can delay the problem)
