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Lesson 23: Balance of Payments & The Current Account

Module 1: Macro Fundamental Analysis

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Video Transcript

in this module we’re going to be looking at the balance of payments

the balance of payments is a record of all payments and monetary transactions between one country and the rest of the world over a given time period via a debit and credit system the balance of payments record covers all transactions between the nation’s individuals business and government bodies and individuals businesses and government bodies of other nations transactions recorded in the balance of payments consist of imports and exports of goods so this could be cars or automobiles services such as insurance services or consultancy services capital such as the transfer of ownership of land and transfers such as foreign aid personal transfers it could be remittances or it could even be for european union members for example sending money for membership to the european union and receiving money from member states would be under transfers as well

in the formula for the balance of payments we attribute the letters bop to represent the balance of payments so the balance of payments equals the cab which is the current account balance plus the capital account ca plus the financial account which is fa plus the balancing item which is bi all of those things have to sum to zero hence the name balance of payment so the current account balance plus the capital account plus the financial account plus the balancing item will sum to zero so let’s have a look at some of the components of the balance payments

so first of all we have the current account and the current account represents the total value of finished goods and services for the purpose of consumption which includes labor and tourism income and transfers in and out of the economy in the formula for the current account we attribute the letters cab to represent the balance of the current account so current account balance equals nx plus ny plus nct and if this looks a little bit complicated i can assure you it’s really quite straightforward we’re going to look at this in more detail when we go over to the spreadsheet and what that means is that the current account balance is made up of net exports so exports minus imports plus net income plus net current transfers

next we have the capital account represented by the letter ca and this is the total value of capital assets in and out of the economy for the purpose of investment so it’s assets that do not create liabilities like land the sale of land and this is what’s known as the capital account in the narrow form

next we have the financial account represented by the letters fa and this is the total value of international financial assets and liabilities ie bonds in and out of the economy so also stocks similar to what we just looked at in the capital accounts but these are assets which create liabilities and the capital account plus the financial account is known as the capital account in the broad form so more recently actually they changed it to capital and financial account but the financial account plus the capital account as we will see later on in the module is what’s known or generally referenced as the capital account in the broad form and the balancing item is the difference between the current account and the capital account in the broad form so we take the current account balance we minus from that the capital account balance in the broad sense so that’s the capital account in the narrow form plus the financial account and that equals the balancing item so please download the attach spreadsheet for balance of payments and we’re going to look at this in more detail here we’re looking at the current account tab of the balance payment spreadsheet and you can see that the current account records flows of international trade in goods and services plus income and transfers and on the left hand side here you can see we have payments made from the rest of the world which are registered as a credit so it’s an outflow of goods and services where money comes in from the rest of the world to the domestic economy and in this we have exports which are finished goods and services sold including labor we have income receipts and this is income from assets owned abroad so interest dividends earnings so think about if somebody in the domestic economy owns property abroad and they are charging rent to a foreign consumer who may be living in the property that money will be sent from the rest of the world to the domestic economy to the owner in the domestic economy and when the money comes in this will be registered in the income receipts part of the current account and will be registered as a credit so a payment from the rest of the world which is an outflow of goods or services and then we have current transfers in and this is the total amount of money transfers into the domestic economy so this could be financial transfers could be foreign aid could be non-life insurance claims etc and below this we have exactly the same but with payments made to the rest of the world which is a debit and this represents an inflow of goods and services as well as of course income and transfers so we have imports which is registering the flow of finished goods and services purchased by the domestic economy so inflow of goods and services with money leaving the domestic economy going to the rest of the world and you can see here we have 550 it says billion but just for ease let’s just say dollars so 550 then we have income payments which is payments on foreign owned assets so interest dividends earnings so in terms of income payments think of somebody in the domestic economy living in a foreign-owned property and paying rent to that person this is going to be a payment made to the rest of the world as the rent payment leaves the domestic economy and goes to the foreign owner and then we have current transfers out which is just the opposite again to this which is total money transfers out of the economy and again financial transfers foreign aid non-life insurance claims etc and when we take these components of the current account and we minus the credits and the debits so more specifically we minus the debits from the credits this gives us three different balances we have the balance of trade which is net exports or nx and this is the 350 dollars in minus the 550 out for imports and you can see in this case this gives us a net export value of minus two hundred and remember this is a monetary value this is minus two hundred dollars this is not the number of imports or exports it’s the monetary value attached to the exports and the imports and when you get the net export number this is the monetary value of all of the exports minus the imports in this case 350 minus 550 leaves us with minus 200 so in this case we have a balance of trade of minus 200 and this is of course is just a demonstration current account this is not a real current account this is just for demonstration purposes we then have the balance of income which is net income or ny as we looked at previously in the slides and you can see that this is just simply income receipts minus income payments so you’re taking money which has entered the domestic economy from the rest of the world in the form of income receipts and from this you are taking the income payment so payments on foreign owned assets so money which has left the domestic economy going to the rest of the world and you can see here in order to get to our net income our balance of income we take 150 and we minus from that 200 and that leaves us with a negative value of minus 50 in terms of net income and finally we have the balance of transfers and again we just do the same thing we take our 100 and we minus the 100 which has come into the domestic economy and from this 100 which has come into the domestic economy we minus the 50 which has left the domestic economy to the rest of the world as total money transfers out and this actually gives us a positive total here of 50 so we have a balance of trade or net exports at minus two hundred dollars net income the balance of income at minus fifty dollars and we have balance of transfers net current transfers which is the nct parts here of plus fifty dollars and to get the overall current account surplus or deficit or the overall balance of the current account here we just simply take net exports plus net income plus net current transfers and you can see this leaves us with a total minus 200 deficit in the current account and what this means is that 200 more is being sent abroad than it actually is coming into the economy and a deficit in the current account means that the domestic economy with the current account deficit is a net borrower because in order to send 200 extra abroad than you have coming into the economy you have to borrow the money the money has to come from somewhere so a country or an economy with the current account deficit is a net borrower in the global markets place and conversely if we see a country or an economy with a current account surplus which would just simply be when we do the same calculations here we end up with a positive current account balance this economy is a net lender in the global marketplace and it means that more money is coming into the economy than is being sent out for example in the form of imports so when somebody in the domestic economy imports something they’re sending money out of the country and a surplus in the current account shows that overall more money is coming into the economy than it is leaving the economy