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Balance of Payments Balance of Payments A country’s balance of payments accounts are a summary of all of the country’s transactions with other countries. There are two important accounts within the balance of payments: the current account and the financial account (formerly known as the capital account). The current account records a nation’s exports and imports of goods and services, and also includes net investment income and net transfers. The financial account records the difference between a country’s sale of assets to foreigners and its purchase of assets from foreigners. The balance of payments is essential for making sense of a nation’s position in the global economy. The current account records a nation’s exports and imports of goods and services. It also includes net investment income (U.S. earnings on investment abroad minus foreign earnings from capital invested in the United States) and net transfers (e.g., foreign aid sent to other countries and funds that immigrants send to family abroad). The financial account records the flows of money from the purchase and sale of assets domestically and abroad, including financial assets (like stocks and bonds) as well as direct foreign investment (like business and real estate). For example, U.S. investors might buy a hotel building in Tokyo or shares of stock in a Swedish company while foreign investors might buy a factory in the United States or stock in a U.S. company. Foreign assets are bought and sold using currencies purchased on foreign exchange markets. The financial flows recorded in the financial account are part of the loanable funds market. Foreign investors provide funds that are used to purchase assets, which means they supply loanable funds. Changes in the supply of loanable funds affect the equilibrium real interest rate in the loanable funds market, which then affects a country’s investment, aggregate demand, output, employment, and price level. When classifying a transaction, consider whether a country uses (loses) or earns (gains) foreign currency. Money coming in to a country is a credit, because you sell domestic goods or assets. Money going out of a country is a debit, because you are buying foreign goods or assets. All transactions cause both a credit and a debit – a credit for one country and a debit for the other. Because of this, the current account balance and financial account balance must equal zero. When they do not the central bank must buy or sell currency to resolve the imbalance. Thus the full balance of payments is CA + FA + ∆off reserves = 0. Changes in official reserves are critical in fixed exchange rate systems for maintaining exchange rate values that are not market clearing values. Balance of Payments Simulation Balance of Payments Tracking Sheet Country Name: _____________________________________ Merchandise Trade Transactions: +/- $ Amount _______________________________________ ________________ _______________________________________ ________________ _______________________________________ ________________ _______________________________________ ________________ Services Transactions: _______________________________________ ________________ _______________________________________ ________________ _______________________________________ ________________ _______________________________________ ________________ Transfer Payment Transactions: _______________________________________ ________________ Investment Income Transactions: _______________________________________ ________________ Financial/Capital Transactions: _______________________________________ ________________ _______________________________________ ________________ _______________________________________ ________________ _______________________________________ ________________ Balance of Payments Simulation Balance of Payments Accounting Sheet Country Name: _____________________________________ Current Account Exports of Goods: ___________________ Imports of Goods: ___________________ Exports of Services: ___________________ Imports of Services: ___________________ Balance of Trade: ___________________ Net Investment Income: ___________________ Net Transfers: ___________________ Balance of Current Account: ___________________ Financial/Capital Account Capital Going Abroad: ___________________ Capital Coming In: ___________________ Balance of Financial/Capital Account: ___________________ Official Reserves Account Official Reserves Imbalance Transaction: ___________________ TOTAL BALANCE OF PAYMENTS: $0 Farmer Wallace from Dorne T-Shirt Supply sells Winterfell sells 1 ton of t-shirts to Winterfell grain to the Dorne Warehouse for $500. Grocery Store for $250. Dorne Movie Theater sells Winterfell Wolf Company movie posters to sells five assembly line Winterfell Film Corp for robots to Dorne for $300. $500. Winslow from Winterfell Dorothy from Dorne Programming Company sends $50 to her cousin sells software design to Winnie from Winterfell. Dorne Graphics for $20. Duddly from Dorne Winslow from Winterfell designs new uniforms for receives $30 for his time the Winterfell hockey as an interior designer in team for $40. Dorne. Duke from Dorne West Corporation in receives $50 for his Winterfell sends Dolly business consultation with from Dorne the $40 she Last Chance Inc in earned in stock dividends. Winterfell. Duodenum from Dorne Washi from Winterfell purchases stock in sells bonds from Western Winterfell Publishing Calendar Corporation for Company for $2200. $1600 to Delilah from Dorne. Weeble from Winterfell Darren sells Warren from Waterworks purchases a Winterfell a Putt-Putt $1500 water slide from Golf course for $1800. Dorne resident Dror. Balance of Payments Simulation Directions You and your partner are part of one country, while the other two people in the group are part of another country. You will draw cards which explain an international transaction, which must be documented appropriately on the balance of payment accounts of both countries. Each country will take turns choosing a card and read it aloud to the group. Then the group will make a determination about what kind of transaction is taking place, and will write it in the corresponding section of their Balance of Payments Tracking Sheet. Keep in mind both countries must write down the transaction – if it is a credit for one country, it must be a debit for the other country. After pulling all 14 cards, both countries should tabulate their final balance of payments using the Balance of Payments Accounting Sheet. Remember that in addition the final balance of payments equaling zero, both the Current Account for each team and the Financial/Capital Account for each team should balance to zero as well. .
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