CHAPTER 19
THE BALANCE-OF-PAYMENTS ACCOUNTS
Learning Objectives:
■ Explain balance-of-payments accounting terms and concepts.
I. Outline
Introduction
– China’s Trade Surpluses and Deficits
Credits, Debits, and Sample Entries in Balance-of-Payments Accounting
Assembling a Balance-of-Payments Summary Statement
Balance-of-Payments Summary Statement for the United States
International Investment Position of the United States
Summary
II. Special Chapter Features
In the Real World: Current Account Deficits
In the Real World: U.S. Trade Deficits with Canada, China, Japan, and Mexico
In the Real World: Trends in the U.S. International Investment Position
III. Purpose of Chapter
The purpose of this chapter is to present the basic principles of balance-of-payments
IV. Teaching Tips
A. Students often find balance-of-payments accounting uninteresting. However, in recent
years, U.S. trade deficits, and particularly the deficits with China, have been continuously in the
news. The opening vignette in this chapter provides background on this issue and will hopefully
B. As we indicate in footnote 2 on page 450, “capital” now has a very specific and limited
208
meaning in the U.S. balance-of-payments accounts. In this chapter and subsequent chapters,
though, we sometimes call the “financial” account the “capital/financial” account in recognition
of the fact that economists and other analysts still regularly refer to such flows as “capital” flows.
C. As we note in footnote 1 on page 450, the IMF and the U.S. Department of Commerce
have changed the presentation format of financial account transactions in the BOP accounts. The
new format records increases in U.S. financial assets held abroad with a plus sign (formerly a
minus sign), as well as increases in foreign assets held in the United States with a plus sign
(previously also the case). We have maintained the debit (minus sign)/credit (plus sign) format
in this chapter because we think it is more useful for discussing payments outward and payments
inward for a country.
D. The new IMF/Department of Commerce recording format has also eliminated the
distinction, in the BOP accounting framework, between short-term and long-term financial
flows. The new format does distinguish, however, between “direct investment” and “portfolio
F. In the balance-of-payments sample transactions, transaction 7 was included in order to
bring Category III into the examples. You may want to indicate that this type of transaction is
unlikely to occur very often in a world of basically floating exchange rates, but that it can be
common in a regime of fixed rates.
V. Answers to End-of-Chapter Questions and Problems
1. The initiating entries would be as follows (not enough information is generally given to
ascertain the accompanying offsetting debit or credit entry):
wheat shipment – credit entry in category I under “exports of goods”; the accompanying
debit entry would be in category I under “unilateral transfers made (secondary
income paid)”
209
textile machinery imports – debit entry in category I under “imports of goods”
Zurich bank account – debit entry of $500 in category II, “increase in U.S. private assets
abroad (portfolio investment)”
2. The financial account in the balance of payments indicates the net asset transfers between
the home country and foreign countries during the time period under consideration. A net debit
balance (financial account deficit or net capital outflow) indicates that home country
3. The “net international investment position” shows the total existing stock of foreign
assets (physical and financial) owned by U.S. citizens and government minus the total existing
stock of U.S. assets (physical and financial) owned by foreign citizens and governments. If the
4. A country such as China can have a current account surplus that is larger than its surplus
210
5. Keeping track of the financial account provides information on the specific nature of
developments in the relative holdings of foreign assets by domestic citizens and government and
home country assets held by foreign citizens and government. For example, the analyst can
6. Since Y = C + I + G + (X – M), the current account balance can be defined as (X – M) =
7. When the initial investment is made, say the purchase of a foreign production facility by
a Country A firm, there is both a debit in the financial account of country A [“increase in private
assets abroad (direct investment)”) and a credit in A’s financial account [either an “increase in
8. In balance-of-payments accounting, the transactions would be recorded for country A as
follows:
ITEM (i): Credit: Category I, Exports of goods, + $1,000
211
The merchandise trade balance improves by $1,000 (the credit entry for exports); the
current account balance improves by $500 [the sum of the $1,000 export credit entry and the
– $500 unilateral transfers (secondary income entry)]; the official reserve transactions balance
has a net effect of zero [the $500 improvement in the current account is matched by the – $500
change (- $1,000 + $500) in the private assets account.
9. There is validity to this point because of the identity (X – M) = S + (T – G) – I. A
10. Because every international economic transaction is recorded in a country’s balance-of-
payments account as both a debit entry (with a negative sign) and a credit entry (with a positive
sign), the sum of all the debits must equal (with opposite sign) the sum of all the credits. Due to
the fact that current account transactions and financial account transactions comprise the entire
VI. Sample Exam Questions
A.
E
Es
ss
sa
ay
y
Q
Qu
ue
es
st
ti
io
on
ns
s
1. Why might detailed information on the state of the balance of payments be useful to
economists and to policymakers? Which of the six “balances” discussed in the text does the U.S.
2. Suppose that home country A has the following transactions with foreign countries
(represented by foreign country B). For each transaction, indicate and explain the appropriate
debit and credit entry in A’s balance-of-payments accounts.
(a) A firm in country A sells $6,000 of steel to a country B firm. Payment is made by
the firm in B drawing down its checking account in a country A commercial bank.
212
country A bank.
Next, using the debit and credit entries that you have constructed, and assuming that these
3. Suppose that you had to explain to a person in the street (who is not an economist) why a
current account deficit must be accompanied by a financial or capital account surplus. What
would you say?
4. “Since the statistical discrepancy in the U.S. balance-of-payments accounts is so large,
5. How is a country’s net international investment position related to that country’s balance–
of-payments accounts? When might the net international investment position not change from
the end of one year to the end of the next year? Explain.
6. Identify and distinguish among, in balance-of-payments accounting, various “balances”
that can appear in a country’s balance-of-payments statement. What must conceptually be the
numerical relationship between a country’s “balance on current account” (or “current account
7. For each of the statements below, explain why the statement is either TRUE or FALSE.
(a) “If a country’s income is less than its spending, then the country will have a
surplus in its current account.”
(b) “If a country has a merchandise trade deficit, then the country must also have
8. When might a current account deficit be a reflection of the fact that “good things” are
happening in the economy?