Class notes
The Balance of Payments & Exchange Rates
- Course
- Institution
Detailed notes on The Balance of Payments & Exchange Rates
[Show more]
Seller
Follow
nkgnd
Content preview
The Balance of Payments & Exchange RatesThe balance of payments account
A country’s balance of payments account records all the flows of money between residents of
that country and the rest of the world. Receipts of money from abroad are regarded as credits
and are entered in the accounts with a positive sign. Outflows of money from the country are
regarded as debits and are entered with a negative sign.
There are three main parts of the balance of payments account:
• Current account
• Capital account
• Financial account
The current account
Normally divided into four subdivisions, the current account records:
• The trade in goods account: records imports and exports of physical goods (visibles).
Exports are credited (as they result in an inflow of money), and imports debited. The
balance of these is known as ‘the balance on trade in goods’ or ‘balance of visible
trade’ or ‘merchandise balance’. Exports > imports = surplus and vice versa.
• The trade in services account: records imports and exports of services (e.g. transport,
insurance, tourism etc.). Therefore, the purchase of a foreign holiday, for example,
would be debited as it is an outflow of money from the country. Whist the purchase of
insurance from within the country by a foreign individual would be credited, for a
similar reason. The balance of these is called the services balance.
• Income flows: These consist of wages, interest and profits flowing into and out of the
country. For instance, dividends earned by a foreign resident from shares in a UK
company would be an outflow of money and subsequently debited.
• Current transfers of money: These include international transfers of money by
governments, private individuals and firms. Transfers out of the country are debits.
Transfers into the country (e.g. money sent from Greece to a Greek student studying
in the UK) are credits.
Note: the balance of both the goods and services accounts together is known as the balance
on trade in goods and services or simply the balance of trade.
The current account balance is the overall balance of all the above four subdivisions. A
current account surplus is where credits exceed debits, and a deficit is the opposite.
The capital account
The capital account relates to the acquisition and disposal of non-financial assets. This
comprises two elements:
, • Capital transfers: these are the flows of funds, into the country (credits) and out of the
country (debits), associated with the transfer of ownership of fixed assets (e.g. land).
These transfers include money that migrants bring into the country and official debt
forgiveness by governments.
• Acquisition or disposal of non-produced, non-financial assets: covers intangibles such
as the sales and purchases of patents, copyrights and trademarks.
Typically, the balance on the capital account is small in comparison to that on the current and
financial accounts.
The financial account
Unlike the current account which is concerned with money incomes, the financial account is
concerned with the purchase and sale of assets.
• Direct investment: this involves a significant and lasting interest in a business in
another country. If a foreign company invests money from abroad in one of its
branches or associated companies in the UK, this represents an inflow of money when
investment is made and is thus a credit item. Note that this is the acquisition or sale of
assets (e.g. a factory or farm, or takeover of a whole company), not the imports or
exports of equipment or profit from investment.
• Portfolio investment: this relates to transactions in debt and equity securities (shares)
which do not result in the investor having any significant influence on the operations
of a business. If a UK resident, for instance, buys shares in an overseas company, this
is an outflow of funds and is hence a debit item.
• Other investment and financial flows: these consist primarily of various types of
short-term monetary flows between the UK and the rest of the world. For example,
deposits by overseas residents in UK banks and loans to the UK from abroad are
credit items, since they represent an inflow of money.
• Flows to and from the reserves: countries hold reserves of gold and foreign
currencies. From time to time they will sell some of these reserves to purchase their
currency on the foreign exchange market; normally as a means of supporting the rate
of exchange. Drawing on reserves represents a credit item in the balance of payments
account (money drawn from the reserves represents an inflow to the balance of
payments). Whereas, building up the reserves counts as a debit item in the balance of
payments (represents an outflow from it to the reserves).
Overall
When all the components of the balance of payments account are taken together, the balance
of payments should exactly balance – credits should equal debits. If they are not equal, the
rate of exchange would have to adjust until they were, or the government would have to
intervene to make them equal.
When the statistics are compiled, however, several errors are likely to occur. Thus, there will
not be a balance. To correct this, a net errors and omissions item is included in the accounts.
This ensures that there will be an exact balance. The main reason for errors is that the
statistics are obtained from a number of sources, and there are often delays before items are
recorded and sometimes omissions too.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller nkgnd. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $3.87. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
67096 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now