Balance of Payments

Like many definitions , this one requiers clarification , especially with respect to the coverage and valuation of economic transactions and the criteria for determinig residency . The coverage of economic transactions refers to both commercial trade dealings and noncomercial transfers , which may or may not be effected through the forigen markets and which may not be satisfactorily recorded because of inadequacies in the system of data collection .

Particularly difficult questions of valuation are posed by noncomercial transactions that take place between domestic and foreign-based units of individual corporations . The determination of residency should ordinarily not be difficult , but even here questions may arise concerning the treatment of overseas military forces and embassies , corporate subsidiaries and international organizations . Transactions are recorded in principle on a double-entry bookkeeping basis . Each transaction enterd in the accounts as a credit must have a corresponding debit and vice versa .

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The distributions commonly made in classifying the various accounts can be seen from the schematic balance of payments in Table 1. 1 . There are many possible interrelationships among the various items showm in Table 1. 1 that arise from the complexities of the market and nonmarket transactions typically recorded for an individual nation . Thus , the receipts and payments arising from merchandise and service exports and imports showm in the current account may have their counterpart debits or credits recored in one or more of the remaining accounts .

The balance of payments must accordingly be looked at as a whole raher than in terms of its individual parts . It follows from double-entry bookkeeping that the balance of payments must always balance : total debits equal total credits . When we speak therefore of a positive or negative balance or a surplus or deficit , we evidently have in mind some particular group or classification of accounts . For example , a positive balance of trade refers to an excess of merchandise exports over merchandisse imports (item 1) and vice versa for a negative balance of trade .

Similarly , a current-account surplus or deficit refers to the difference between receipts and payments coming from exports and imports merchandise and services ( items 1-5 ) . As such , it represents the net contribution of foreign trade to national income and expenditure . The balances on current account and unilateral transders are frequently added together . This balace of items 1-7 constitutrs a measure of net foreign investment . The nation`s long-term foregin investments , which are assumed to have a maturity in excess of one year , are recorded in intem 8 .

These consist generally of direct investment i tanginle physical assets of business frim and of potofolio investment in securities of various kinds . Item 8 may also include private short-term capital movements with maturity of less than one year , which represents changes in foreign – or domoestic-currency working balances intended to facilitate the financing of regular commercial transactions or to take advantage of international differences in interest rates .

There is some controversy , however , as to whether private short-term capital movements should be recorded in whole or in part in item 9 rather than in item 8 . The argument for recording these movements in intem 9 is that they may in large part be transitory in nature ,and further , that they cannot be distingushed readily from official short-term capital transactions . Assume for now that all the private short-term capital transactions are recorded in item 8 . This means that items 9 and 10 in Table 1. 1 represents the “balancing” or “settlement” items in the balance of payments .

These items are applicable in a system in whick exchange rates are fixed by virtue of the nation`s monetary authority standing ready to buy and sell foreign exchange in order to keep the exchange rate at some given level or within a specified range . These official transactions may take the form of increases or decreases in short-term capital assets or libilities or an inflow or outflow of gold or other international monetary reserves . The size of the balancing items can be interpreted consequently as a measure of the foreign exchange authority`s transactions undertaken to maintain exchange-rate stability .

This suggests that if we wish in this context to speak of the balance of payments being in “equilibrium” , the sum of the balancing items should be equal to zero . There should , in other words , be no net movement of official short-term capital and of gold and other international reserves . This will be the case when the total debits and credits in items 1-8 , commonly referred to as the items “above the line” are equal . If the total debts and credits above the line are not equal , we can then speak of a positive or negative balance , or more commonly of a balance-of-payments surplus of deficit .

This surplus or deficit will be reflected “below the line” with opposite sign in the balancing items 9 and 10 . Since the sum of these balancing items follows directly from the difference in totals of items 1-8 , it should be clear that the cause of a surplus or deficit cannot be inferred directly from particular items above the line . The transactions recorded in Table 1. 1 are sometimes interpreted according to wheter they are “autonomous” or “accommodating” in character .

Transactions are considered autonomous insofar as they may be assumed to have been undertaken in response to commercial incentives or political considerations that are given independently of the state of the overall balance of payments or of particular accounts . Thus , items 1-8 in Table1. 1 might be treated as autonomous . Accommodating transactions arise accordingly out of the need to fill the gap between total autonomous debits nd credits . The filling of the gap by a nation`s foreign exchange authority , as recorded in items 9 and 10 , can therefore be considered as accommodating in nature.