CHAPTER 3
THE BALANCE OF PAYMENTS
1. Balance of Payments Defined. What is the balance of payments?
2. BOP Data. What institution provides the primary source of similar statistics for balance of payments
and economic performance worldwide?
3. Importance of BOP. Business managers and investors need BOP data to anticipate changes in host
country economic policies that might be driven by BOP events. From the perspective of business
managers and investors, list three specific signals that a country’s BOP data can provide.
The BOP is an important indicator of pressure on a country’s foreign exchange rate and thus on
4. Flow Statement. What does it mean to describe the balance of payments as a flow statement?
5. Economic Activity. What are the two main types of economic activity measured by a country’s
BOP?
6. Balance. Why does the BOP always “balance”?
7. BOP Accounting. If the BOP were viewed as an accounting statement, would it be a balance sheet of
the country’s wealth, an income statement of the country’s earnings, or a funds flow statement of
money into and out of the country?
8. Current Account. What are the main component accounts of the current account? Give one debit and
one credit example for each component account for the United States.
9. Real versus Financial Assets. What is the difference between a “real” asset and a “financial” asset?
10. Direct versus Portfolio Investments. What is the difference between a direct foreign investment and
a portfolio foreign investment? Give an example of each. Which type of investment is a multinational
industrial company more likely to make?
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of a multinational enterprise or the acquisition of more than 10% of the voting shares of a foreign
corporation. A portfolio investment is the purchase of less than 10% of the voting shares of a foreign
corporation or the purchase of debt instruments. Multinational enterprises are more likely to engage in
direct foreign investment than in portfolio investment.
11. Net International Investment Position. What is a country’s net international investment position,
and how does it differ from the balance of payments?
12. The Financial Account. What are the primary sub-components of the financial account?
Analytically, what would cause net deficits or surpluses in these individual components?
13. Classifying Transactions. Classify the following as a transaction reported in a sub-component of the
current account or the capital and financial accounts of the two countries involved:
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d. A U.S. university gives a tuition grant to a foreign student from Singapore. If the student is
already in the United States, no entry will appear in the balance of payments because payment is
h. An American multinational enterprise buys insurance from a London insurance broker. A debit to
l. The U.S. army buys food for its troops in South Asia from vendors in Thailand. A debit to the
goods part of the U.S. current account; a credit to the goods part of the Thai current account.
m. A Yale graduate gets a job with the International Committee of the Red Cross working in Bosnia
and is paid in Swiss francs. A debit to the income part of the Swiss current account; a credit to the
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view of the smugglers, bank accounts in the United States or somewhere else (probably not
Colombia, possibly Switzerland) would be credited. This imbalance would end up in the errors
and omissions part of the U.S. balance of payments.
p. The U.S. government pays the salary of a Foreign Service Officer working in the U.S. embassy in
Beirut. Diplomats serving in a foreign country are regarded as residents of their home country, so
this payment would not be recorded in any balance of payments accounts. If or when the diplomat
spent the money in Beirut, at that time a debit should be incurred in the goods or services part of
the U.S. current account and a contrary entry in the Lebanon balance of payments. It is doubtful
that the goods or services transaction would get reported or recorded, although on a net basis
changes in bank balances would reflect half of the transaction.
q. A Norwegian shipping firm pays U.S. dollars to the Egyptian government for passage of a ship
through the Suez Canal. If the Norwegian firm paid with dollar balances held in the United States
14. The Balance. What are the main summary statements of the balance of payments accounts, and what
do they measure?
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The overall balance (also called the official settlements balance) is the total change in a country’s
foreign exchange reserves caused by the basic balance plus any governmental action to influence
foreign exchange reserves.
15. Twin Surpluses. Why is China’s twin surpluses—a surplus in both the current and financial
accounts—considered unusual?
16. Capital Mobility—United States. The U.S. dollar has maintained or increased its value over the past
20 years despite running a gradually increasing current account deficit. Why has this phenomenon
occurred?
17. Capital Mobility—Brazil. Brazil has experienced periodic depreciation of its currency over the past
20 years despite occasionally running a current account surplus. Why has this phenomenon occurred?
18. BOP Transactions. Identify the correct BOP account for each of the following transactions.
a. A German-based pension fund buys U.S. government 30-year bonds for its investment portfolio.
Financial account: portfolio investment liabilities
b. Scandinavian Airlines System (SAS) buys jet fuel at Newark Airport for its flight to Copenhagen.
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h. A U.K. corporation purchases a euro-denominated bond from an Italian MNE.
Does not enter the U.S. balance of payments
19. BOP and Exchange Rates. What is the relationship between the balance of payments and a fixed or
floating exchange rate regime?
20. J-Curve Dynamics. What is the J-Curve adjustment path?
21. Evolution of Capital Mobility. Has capital mobility improved steadily over the past 50 years?
22. Restrictions on Capital Mobility. What factors seem to play a role in a government’s choice to
restrict capital mobility?
23. Capital Controls. Which do most countries control, capital inflows or capital outflows? Why?
24. Globalization and Capital Mobility. How does capital mobility typically differ between
industrialized countries and emerging market countries?