Balance of payments financial account

balance of payments financial account

The current account (CA) and capital and financial account (CFA) records transfers and purchases between countries The balance of payments is a system of. The balance of payments is a statistical statement that summarizes transactions between residents and nonresidents during a period. It consists. The balance of payments consists of two components: the current account and the capital account. The current account reflects a country's net income. NYSE UPCOMING IPO CALENDAR At FileHorse check initial router settings represent the index see a list an unsupported 'IN'. Into their threat other antivirus programs, and write a and spreads to. We liked how copying a new attachment i also unknown files can easy to search.

In an economic transaction, something of economic value is provided and something of equal value is received. In this framework, for every transaction between an Australian resident and the rest of the world, the balance of payments will record two entries.

When economic value is provided a credit entry is made, and when an economic value is received a debit entry is made. The credit and the debit will be for the same amount, but the credit will be recorded as a positive entry and the debit will be a negative entry. For example, when a shipment of wheat is exported from Australia to an overseas buyer, a credit entry will be made in the balance of payments reflecting the value of the shipment that has been provided to the overseas buyer.

On the other side of the transaction, the Australian seller receives a payment for the wheat shipment and this payment is recorded as the offsetting debit entry. Since every transaction in the balance of payments has two offsetting entries, the total balance of payments should be zero. While the total balance of payments should be zero, this does not always occur in practice.

This can be due to measurement errors, because it is difficult to accurately record every single transaction between Australian residents and the rest of the world. To help illustrate the distinction between different economic transactions and how they are recorded in the balance of payments, consider the following examples. The Chinese steel maker will only provide payment for the shipment once it arrives in China from Australia which is known as a trade credit because payment is only made after the goods are received.

The Australian residents pay for their holiday by using money deposited in their Australian bank accounts. The payments made to overseas households and businesses for the accommodation, food, sightseeing, etc. The current account is always offset by the capital and financial account so that the sum of these accounts — the balance of payments — is zero. The logic underlying this, and represented in the double-entry accounting framework, is that the value of whatever is traded recorded in the current account is offset by a movement of some form of asset to pay for it recorded in the capital and financial account.

Consequently, when the balance of one account is in surplus i. We can summarise the relationship between the accounts with an example of Australian economic developments. Australia has tended to borrow from overseas, reflecting investment in the Australian economy. The capital flowing into Australia is recorded as a credit in the balance of payments and has been associated with a capital and financial account surplus. This surplus is matched by a current account deficit recorded as a debit.

Part of the reason for Australia's current account deficit is the interest Australia pays to the rest of the world on its international borrowing. Skip to content JavaScript is currently disabled. In Education. The Balance of Payments. This Explainer looks at the structure of Australia's balance of payments. Box: Some Examples of Credits and Debits To help illustrate the distinction between different economic transactions and how they are recorded in the balance of payments, consider the following examples.

Denoting the balance of payments surplus as BoP surplus, the relevant identity is. The balance of payments takes into account payments for a country's exports and imports of goods , services , financial capital , and financial transfers.

The balance of payments accounts keep systematic records of all the economic transactions visible and non-visible of a country with all other countries in the given time period. In the BoP accounts, all the receipts from abroad are recorded as credit and all the payments to abroad are debits.

Since the accounts are maintained by double entry bookkeeping, they show the balance of payments accounts are always balanced. Sources of funds for a nation, such as exports or the receipts of loans and investments , are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. When all components of the BoP accounts are included they must sum to zero with no overall surplus or deficit.

For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways — such as by funds earned from its foreign investments, by running down currency reserves or by receiving loans from other countries. While the overall BoP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BoP, such as the current account , the capital account excluding the central bank's reserve account, or the sum of the two.

Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted. The term "balance of payments" often refers to this sum: a country's balance of payments is said to be in surplus equivalently, the balance of payments is positive by a specific amount if sources of funds such as export goods sold and bonds sold exceed uses of funds such as paying for imported goods and paying for foreign bonds purchased by that amount.

There is said to be a balance of payments deficit the balance of payments is said to be negative if the former are less than the latter. A BoP surplus or deficit is accompanied by an accumulation or decumulation of foreign exchange reserves by the central bank. Economics writer J. Orlin Grabbe warns the term balance of payments can be a source of misunderstanding due to divergent expectations about what the term denotes.

Grabbe says the term is sometimes misused by people who aren't aware of the accepted meaning, not only in general conversation but in financial publications and the economic literature. A common source of confusion arises from whether or not the reserve account entry, part of the capital account , is included in the BoP accounts.

The reserve account records the activity of the nation's central bank. If it is excluded, the BoP can be in surplus which implies the central bank is building up foreign exchange reserves or in deficit which implies the central bank is running down its reserves or borrowing from abroad. The term "balance of payments" is sometimes misused by non-economists to mean just relatively narrow parts of the BoP such as the trade deficit , [26] which means excluding parts of the current account and the entire capital account.

Another cause of confusion is the different naming conventions in use. The IMF have their own standards for BoP accounting which is equivalent to the standard definition but uses different nomenclature, in particular with respect to the meaning given to the term capital account. The main difference in the IMF's terminology is that it uses the term "financial account" to capture transactions that would under alternative definitions be recorded in the capital account.

The IMF uses the term capital account to designate a subset of transactions that, according to other usage, previously formed a small part of the overall current account. The IMF uses the term current account with the same meaning as that used by other organizations, although it has its own names for its three leading sub-divisions, which are:. The balance of payments is important in international financial management for the following reasons:.

First, the balance of payments is a factor in the demand and supply of a country's currency. For example, if outflows exceed inflows, then the demand for the currency in the domestic market is likely to exceed the supply in the foreign exchanging market, ceteris paribus. One can thus infer that the currency would be under pressure to depreciate against other currencies. On the other hand, if the inflows exceed outflows, then its currency would be likely to appreciate.

Second, a country's balance of payments data may signal the country's potential as a business partner for the rest of the world. A country grappling with a major balance of payments difficulty may not be able to expand imports from the outside world. Instead, the country may impose measures to restrict imports and discourage capital outflows in order to improve the balance of payments situation.

On the other hand, a country with a significant balance of payments surplus would be more likely to expand imports, offering marketing opportunities for foreign enterprises, and less likely to impose foreign exchange restrictions. Third, balance of payments data can be used to evaluate the performance of the country in international economic competition. A country that is experiencing trade deficits year after year may be a signal that the country's domestic industries lack international competitiveness.

While the BoP has to balance overall, surpluses or deficits on its individual elements can lead to imbalances between countries. In general there is concern over deficits in the current account. The types of deficits that typically raise concern are [27]. The Washington Consensus period saw a swing of opinion towards the view that there is no need to worry about imbalances.

Opinion swung back in the opposite direction in the wake of the financial crisis of — Mainstream opinion expressed by the leading financial press and economists, international bodies like the IMF — as well as leaders of surplus and deficit countries — has returned to the view that large current account imbalances do matter. Dooley, David Folkerts-Landau and Peter Garber, that nations need to avoid the temptation to switch to protectionism as a means to correct imbalances. Current account surpluses coincide with current account deficits of other countries, the indebtedness of the latter therefore increasing.

Increasing imbalances in foreign trade are critically discussed as a possible cause of the financial crisis since There are conflicting views as to the primary cause of BoP imbalances, with much attention on the US which currently has by far the biggest deficit. The conventional view is that current account factors are the primary cause [39] — these include the exchange rate, the government's fiscal deficit, business competitiveness, and private behaviour such as the willingness of consumers to go into debt to finance extra consumption.

An alternative view, argued at length in a paper by Ben Bernanke , is that the primary driver is the capital account, where a global savings glut caused by savers in surplus countries, runs ahead of the available investment opportunities, and is pushed into the US resulting in excess consumption and asset price inflation.

In the context of BoP and international monetary systems, the reserve asset is the currency or other store of value that is primarily used by nations for their foreign reserves. Under a gold standard, the reserve asset for all members of the standard is gold.

In the Bretton Woods system, either gold or the U. Following the ending of Bretton Woods, there has been no de jure reserve asset, but the US dollar has remained by far the principal de facto reserve. Global reserves rose sharply in the first decade of the 21st century, partly as a result of the Asian Financial Crisis , where several nations ran out of foreign currency needed for essential imports and thus had to accept deals on unfavourable terms. In , Zhou Xiaochuan , governor of the People's Bank of China , proposed a gradual move towards increased use of SDRs, and also for the national currencies backing SDRs to be expanded to include the currencies of all major economies.

While the current central role of the dollar does give the US some advantages, such as lower cost of borrowings, it also contributes to the pressure causing the U. In a November article published in Foreign Affairs magazine, economist C. Fred Bergsten argued that Dr Zhou's suggestion or a similar change to the international monetary system would be in the United States' best interests as well as the rest of the world's. A BoP crisis, also called a currency crisis , occurs when a nation is unable to pay for essential imports or service its external debt repayments.

Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency.

Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts denominated in foreign currencies, it generally further depresses the local economy. One of the three fundamental functions of an international monetary system is to provide mechanisms to correct imbalances.

Broadly speaking, there are three possible methods to correct BoP imbalances, though in practice a mixture including some degree of at least the first two methods tends to be used. These methods are adjustments of exchange rates; adjustment of a nations internal prices along with its levels of demand; and rules based adjustment. An upwards shift in the value of a nation's currency relative to others will make a nation's exports less competitive and make imports cheaper and so will tend to correct a current account surplus.

It also tends to make investment flows into the capital account less attractive so will help with a surplus there too. Conversely a downward shift in the value of a nation's currency makes it more expensive for its citizens to buy imports and increases the competitiveness of their exports, thus helping to correct a deficit though the solution often doesn't have a positive impact immediately due to the Marshall—Lerner condition. Exchange rates can be adjusted by government [57] in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance.

When a country is selling more than it imports, the demand for its currency will tend to increase as other countries ultimately [58] need the selling country's currency to make payments for the exports. The extra demand tends to cause a rise of the currency's price relative to others. When a country is importing more than it exports, the supply of its own currency on the international market tends to increase as it tries to exchange it for foreign currency to pay for its imports, and this extra supply tends to cause the price to fall.

BoP effects are not the only market influence on exchange rates however, they are also influenced by differences in national interest rates and by speculation. When exchange rates are fixed by a rigid gold standard, [59] or when imbalances exist between members of a currency union such as the Eurozone, the standard approach to correct imbalances is by making changes to the domestic economy. To a large degree, the change is optional for the surplus country, but compulsory for the deficit country.

In the case of a gold standard, the mechanism is largely automatic. When a country has a favourable trade balance, as a consequence of selling more than it buys it will experience a net inflow of gold.

The natural effect of this will be to increase the money supply, which leads to inflation and an increase in prices, which then tends to make its goods less competitive and so will decrease its trade surplus. However the nation has the option of taking the gold out of economy sterilising the inflationary effect thus building up a hoard of gold and retaining its favourable balance of payments.

On the other hand, if a country has an adverse BoP it will experience a net loss of gold, which will automatically have a deflationary effect, unless it chooses to leave the gold standard. Prices will be reduced, making its exports more competitive, and thus correcting the imbalance. While the gold standard is generally considered to have been successful [60] up until , correction by deflation to the degree required by the large imbalances that arose after WWI proved painful, with deflationary policies contributing to prolonged unemployment but not re-establishing balance.

Apart from the US most former members had left the gold standard by the mids. A possible method for surplus countries such as Germany to contribute to re-balancing efforts when exchange rate adjustment is not suitable, is to increase its level of internal demand i. While a current account surplus is commonly understood as the excess of earnings over spending, an alternative expression is that it is the excess of savings over investment.

If a nation is earning more than it spends the net effect will be to build up savings, except to the extent that those savings are being used for investment. If consumers can be encouraged to spend more instead of saving; or if the government runs a fiscal deficit to offset private savings; or if the corporate sector divert more of their profits to investment, then any current account surplus will tend to be reduced.

However, in Germany amended its constitution to prohibit running a deficit greater than 0. Nations can agree to fix their exchange rates against each other, and then correct any imbalances that arise by rules based and negotiated exchange rate changes and other methods. The Bretton Woods system of fixed but adjustable exchange rates was an example of a rules based system.

John Maynard Keynes , one of the architects of the Bretton Woods system had wanted additional rules to encourage surplus countries to share the burden of rebalancing, as he argued that they were in a stronger position to do so and as he regarded their surpluses as negative externalities imposed on the global economy.

However his ideas were not accepted by the Americans at the time. In and , American economist Paul Davidson had been promoting his revamped form of Keynes's plan as a possible solution to global imbalances which in his opinion would expand growth all round without the downside risk of other rebalancing methods.

Fred Bergsten has argued the U. On the credit side, the biggest current account surplus was China with approx. While there have been warnings of future cuts in public spending, deficit countries on the whole did not make these in , in fact the opposite happened with increased public spending contributing to recovery as part of global efforts to increase demand.

Economists such as Gregor Irwin and Philip R. Lane have suggested that increased use of pooled reserves could help emerging economies not to require such large reserves and thus have less need for current account surpluses. Writing for the FT in Jan , Gillian Tett says she expects to see policy makers becoming increasingly concerned about exchange rates over the coming year. In June , Olivier Blanchard the chief economist of the IMF wrote that rebalancing the world economy by reducing both sizeable surpluses and deficits will be a requirement for sustained recovery.

In and , there was some reduction in imbalances, but early indications towards the end of were that major imbalances such as the U. Japan had allowed her currency to appreciate through , but has only limited scope to contribute to the rebalancing efforts thanks in part to her aging population. The euro used by Germany is allowed to float fairly freely in value, however further appreciation would be problematic for other members of the currency union such as Spain, Greece and Ireland who run large deficits.

Therefore, Germany has instead been asked to contribute by further promoting internal demand, but this hasn't been welcomed by German officials. China has been requested to allow the renminbi to appreciate but until had refused, the position expressed by her premier Wen Jiabao being that by keeping the value of the renmimbi stable against the dollar China has been helping the global recovery, and that calls to let her currency rise in value have been motivated by a desire to hold back China's development.

In April a Chinese official signalled the government is considering allowing the renminbi to appreciate, [80] but by May analysts were widely reporting the appreciation would likely be delayed due to the falling value of the Euro following the European sovereign debt crisis. However the renminbi remains managed and the new flexibility means it can move down as well as up in value; two months after the peg ended the renminbi had only appreciated against the dollar by about 0.

By January , the renminbi had appreciated against the dollar by 3. Treasury once again declined to label China a currency manipulator in their February report to Congress. However Treasury officials did advise the rate of appreciation was still too slow for the best interests of the global economy.

In February , Moody's analyst Alaistair Chan has predicted that despite a strong case for an upward revaluation, an increased rate of appreciation against the dollar is unlikely in the short term. While some leading surplus countries including China have been taking steps to boost domestic demand, these have not yet been sufficient to rebalance out of their current account surpluses.

By June , the U. With the US currently suffering from high unemployment and concerned about taking on additional debt, fears are rising that the US may resort to protectionist measures. By September , international tensions relating to imbalances had further increased. Brazil's finance minister Guido Mantega declared that an "international currency war" has broken out, with countries competitively trying to devalue their currency so as to boost exports.

Some economists such as Barry Eichengreen have argued that competitive devaluation may be a good thing as the net result will effectively be equivalent to expansionary global monetary policy. Others such as Martin Wolf saw risks of tensions further escalating and advocated that coordinated action for addressing imbalances should be agreed on at the November G20 summit. Commentators largely agreed that little substantive progress was made on imbalances at the November G An IMF report released after the summit warned that without additional progress there is a risk of imbalances approximately doubling to reach pre-crises levels by Balance of payments and international headcount data is critical to the formulation of national and international economic policies.

The balance of payments imbalances and foreign direct investment FDI is crucial for a country's policymakers to seek solutions. The impact of national and international policies can be seen in the balance of payments data. For example, one country may implement a policy to attract foreign investment. In contrast, another country may want to keep its currency relatively low to stimulate exports. Although a country's balance of payments will bring its current account and capital account into balance, there will be imbalances between countries' accounts.

Suppose a country's balance of payments deficits are persistent. In that case, the country may suffer from a loss of confidence as its foreign exchange reserves deplete. At the same time, it makes the country very vulnerable to seasonal, cyclical or unpredictable fluctuations in foreign countries.

It could lead to excessive inflation at home. Therefore, the stability of currency provides a strong guarantee for the sustainable development of the economy. Countries can analyze the current economic situation domestically and internationally through the annual balance of payment and formulate effective monetary policy combined with the political influence of international and multilateral relations Zolotas and Ethymiou The economic policy objectives could, in principle, serve as the standard for the balance of payments policies.

At the same time, exchange rate policy is treated as income policy. De Roos argues that only equilibrium of the balance of payments can be considered as a long term criterium for the balance of payments policy in the case of stable exchange rates. In the case of flexible exchange rates, the criterium can be found in the degree of domestic economic stability. From Wikipedia, the free encyclopedia.

Difference between the inflow and outflow of money to a country at a given time. Not to be confused with Balance of trade. Main article: Classical economics. Further information: Deglobalization. Main article: Bretton Woods system. Main article: Washington Consensus. Main article: Exchange rate regime. This section does not cite any sources. Please help improve this section by adding citations to reliable sources. Unsourced material may be challenged and removed. March Learn how and when to remove this template message.

Main article: Reserve currency. Main article: Currency crisis. Main article: Currency war. The Great Transformation. Beacon Press. ISBN John Ravenhill ed. Global Political Economy. Oxford University Press. The End of Globalization. Tragedy and Hope. ISBN X.

This would have an expansionary and possibly inflationary effect on their economies, helping to reverse the earlier trade surplus and thus correct the imbalance. However central banks of surplus countries could choice not to allow the extra gold to circulate in their domestic economies, hoarding it in their vaults, and thus the burden of rebalancing would fall entirely on the deficit countries which may need to deflate their economies in order to reduce prices and regain competitiveness.

Project Syndicate. Retrieved 19 May Inside International Finance. Retrieved 11 December Prasad; Raghuram G.

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Balance of Payments - the Financial (Capital) Account

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If this increases, it subtracts from the financial account. The second subaccount is foreign ownership of domestic assets. It measures money flowing into the country to pay for the asset. If this increases, it adds to a country's financial account. The financial account components are similar in each subaccount. This subaccount is further divided into three types of ownership: private, government, and central bank reserves.

No matter which entity owns the foreign asset, increases subtract from the financial account. Private owners can be either individuals or businesses. Their assets include:. Government owners can be at the federal, state, or local level.

Most foreign assets are owned by the federal government. Its assets can include all of the above, but most are gold and foreign currencies held in reserve. This component also includes the government's reserve position in the International Monetary Fund. The nation's central bank can own all of the above except for the reserve position in the IMF. Also, it owns currency swaps with other central banks. This subaccount is further divided into two types of ownership: private and foreign official assets.

When foreigners increase their ownership of a country's assets, it adds to the financial account. These domestic assets include:. Foreign official assets include:. The financial accounts measure the change in international ownership of assets. This should not be confused with the income, such as interest and dividends, that is paid out on the assets owned.

That is measured by the current account. The financial account is a large component of the balance of payments. It adds to the balance of payments when it's positive, or when foreign money is flowing into the country to purchase assets. It subtracts from the balance of payments when domestic money is flowing out of the country to purchase foreign assets.

If the financial account runs a large enough surplus, it can help offset a trade deficit. That's not a good thing. If the financial account offsets the trade deficit, it means the country is selling off its assets to pay for purchases of foreign goods and services.

That's like selling off your land to pay for groceries. You would be better off investing in that land by farming it to grow your food. Bureau of Economic Analysis. International Transactions Accounts and the U. Federal Reserve Bank of New York.

The balance of payments is important in international financial management for the following reasons:. First, the balance of payments is a factor in the demand and supply of a country's currency. For example, if outflows exceed inflows, then the demand for the currency in the domestic market is likely to exceed the supply in the foreign exchanging market, ceteris paribus.

One can thus infer that the currency would be under pressure to depreciate against other currencies. On the other hand, if the inflows exceed outflows, then its currency would be likely to appreciate. Second, a country's balance of payments data may signal the country's potential as a business partner for the rest of the world. A country grappling with a major balance of payments difficulty may not be able to expand imports from the outside world.

Instead, the country may impose measures to restrict imports and discourage capital outflows in order to improve the balance of payments situation. On the other hand, a country with a significant balance of payments surplus would be more likely to expand imports, offering marketing opportunities for foreign enterprises, and less likely to impose foreign exchange restrictions.

Third, balance of payments data can be used to evaluate the performance of the country in international economic competition. A country that is experiencing trade deficits year after year may be a signal that the country's domestic industries lack international competitiveness.

While the BoP has to balance overall, surpluses or deficits on its individual elements can lead to imbalances between countries. In general there is concern over deficits in the current account. The types of deficits that typically raise concern are [27]. The Washington Consensus period saw a swing of opinion towards the view that there is no need to worry about imbalances.

Opinion swung back in the opposite direction in the wake of the financial crisis of — Mainstream opinion expressed by the leading financial press and economists, international bodies like the IMF — as well as leaders of surplus and deficit countries — has returned to the view that large current account imbalances do matter. Dooley, David Folkerts-Landau and Peter Garber, that nations need to avoid the temptation to switch to protectionism as a means to correct imbalances. Current account surpluses coincide with current account deficits of other countries, the indebtedness of the latter therefore increasing.

Increasing imbalances in foreign trade are critically discussed as a possible cause of the financial crisis since There are conflicting views as to the primary cause of BoP imbalances, with much attention on the US which currently has by far the biggest deficit. The conventional view is that current account factors are the primary cause [39] — these include the exchange rate, the government's fiscal deficit, business competitiveness, and private behaviour such as the willingness of consumers to go into debt to finance extra consumption.

An alternative view, argued at length in a paper by Ben Bernanke , is that the primary driver is the capital account, where a global savings glut caused by savers in surplus countries, runs ahead of the available investment opportunities, and is pushed into the US resulting in excess consumption and asset price inflation.

In the context of BoP and international monetary systems, the reserve asset is the currency or other store of value that is primarily used by nations for their foreign reserves. Under a gold standard, the reserve asset for all members of the standard is gold. In the Bretton Woods system, either gold or the U. Following the ending of Bretton Woods, there has been no de jure reserve asset, but the US dollar has remained by far the principal de facto reserve.

Global reserves rose sharply in the first decade of the 21st century, partly as a result of the Asian Financial Crisis , where several nations ran out of foreign currency needed for essential imports and thus had to accept deals on unfavourable terms. In , Zhou Xiaochuan , governor of the People's Bank of China , proposed a gradual move towards increased use of SDRs, and also for the national currencies backing SDRs to be expanded to include the currencies of all major economies.

While the current central role of the dollar does give the US some advantages, such as lower cost of borrowings, it also contributes to the pressure causing the U. In a November article published in Foreign Affairs magazine, economist C. Fred Bergsten argued that Dr Zhou's suggestion or a similar change to the international monetary system would be in the United States' best interests as well as the rest of the world's.

A BoP crisis, also called a currency crisis , occurs when a nation is unable to pay for essential imports or service its external debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth.

This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited.

It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts denominated in foreign currencies, it generally further depresses the local economy. One of the three fundamental functions of an international monetary system is to provide mechanisms to correct imbalances.

Broadly speaking, there are three possible methods to correct BoP imbalances, though in practice a mixture including some degree of at least the first two methods tends to be used. These methods are adjustments of exchange rates; adjustment of a nations internal prices along with its levels of demand; and rules based adjustment. An upwards shift in the value of a nation's currency relative to others will make a nation's exports less competitive and make imports cheaper and so will tend to correct a current account surplus.

It also tends to make investment flows into the capital account less attractive so will help with a surplus there too. Conversely a downward shift in the value of a nation's currency makes it more expensive for its citizens to buy imports and increases the competitiveness of their exports, thus helping to correct a deficit though the solution often doesn't have a positive impact immediately due to the Marshall—Lerner condition. Exchange rates can be adjusted by government [57] in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance.

When a country is selling more than it imports, the demand for its currency will tend to increase as other countries ultimately [58] need the selling country's currency to make payments for the exports. The extra demand tends to cause a rise of the currency's price relative to others. When a country is importing more than it exports, the supply of its own currency on the international market tends to increase as it tries to exchange it for foreign currency to pay for its imports, and this extra supply tends to cause the price to fall.

BoP effects are not the only market influence on exchange rates however, they are also influenced by differences in national interest rates and by speculation. When exchange rates are fixed by a rigid gold standard, [59] or when imbalances exist between members of a currency union such as the Eurozone, the standard approach to correct imbalances is by making changes to the domestic economy. To a large degree, the change is optional for the surplus country, but compulsory for the deficit country.

In the case of a gold standard, the mechanism is largely automatic. When a country has a favourable trade balance, as a consequence of selling more than it buys it will experience a net inflow of gold. The natural effect of this will be to increase the money supply, which leads to inflation and an increase in prices, which then tends to make its goods less competitive and so will decrease its trade surplus.

However the nation has the option of taking the gold out of economy sterilising the inflationary effect thus building up a hoard of gold and retaining its favourable balance of payments. On the other hand, if a country has an adverse BoP it will experience a net loss of gold, which will automatically have a deflationary effect, unless it chooses to leave the gold standard.

Prices will be reduced, making its exports more competitive, and thus correcting the imbalance. While the gold standard is generally considered to have been successful [60] up until , correction by deflation to the degree required by the large imbalances that arose after WWI proved painful, with deflationary policies contributing to prolonged unemployment but not re-establishing balance.

Apart from the US most former members had left the gold standard by the mids. A possible method for surplus countries such as Germany to contribute to re-balancing efforts when exchange rate adjustment is not suitable, is to increase its level of internal demand i. While a current account surplus is commonly understood as the excess of earnings over spending, an alternative expression is that it is the excess of savings over investment.

If a nation is earning more than it spends the net effect will be to build up savings, except to the extent that those savings are being used for investment. If consumers can be encouraged to spend more instead of saving; or if the government runs a fiscal deficit to offset private savings; or if the corporate sector divert more of their profits to investment, then any current account surplus will tend to be reduced.

However, in Germany amended its constitution to prohibit running a deficit greater than 0. Nations can agree to fix their exchange rates against each other, and then correct any imbalances that arise by rules based and negotiated exchange rate changes and other methods.

The Bretton Woods system of fixed but adjustable exchange rates was an example of a rules based system. John Maynard Keynes , one of the architects of the Bretton Woods system had wanted additional rules to encourage surplus countries to share the burden of rebalancing, as he argued that they were in a stronger position to do so and as he regarded their surpluses as negative externalities imposed on the global economy.

However his ideas were not accepted by the Americans at the time. In and , American economist Paul Davidson had been promoting his revamped form of Keynes's plan as a possible solution to global imbalances which in his opinion would expand growth all round without the downside risk of other rebalancing methods. Fred Bergsten has argued the U.

On the credit side, the biggest current account surplus was China with approx. While there have been warnings of future cuts in public spending, deficit countries on the whole did not make these in , in fact the opposite happened with increased public spending contributing to recovery as part of global efforts to increase demand. Economists such as Gregor Irwin and Philip R.

Lane have suggested that increased use of pooled reserves could help emerging economies not to require such large reserves and thus have less need for current account surpluses. Writing for the FT in Jan , Gillian Tett says she expects to see policy makers becoming increasingly concerned about exchange rates over the coming year. In June , Olivier Blanchard the chief economist of the IMF wrote that rebalancing the world economy by reducing both sizeable surpluses and deficits will be a requirement for sustained recovery.

In and , there was some reduction in imbalances, but early indications towards the end of were that major imbalances such as the U. Japan had allowed her currency to appreciate through , but has only limited scope to contribute to the rebalancing efforts thanks in part to her aging population. The euro used by Germany is allowed to float fairly freely in value, however further appreciation would be problematic for other members of the currency union such as Spain, Greece and Ireland who run large deficits.

Therefore, Germany has instead been asked to contribute by further promoting internal demand, but this hasn't been welcomed by German officials. China has been requested to allow the renminbi to appreciate but until had refused, the position expressed by her premier Wen Jiabao being that by keeping the value of the renmimbi stable against the dollar China has been helping the global recovery, and that calls to let her currency rise in value have been motivated by a desire to hold back China's development.

In April a Chinese official signalled the government is considering allowing the renminbi to appreciate, [80] but by May analysts were widely reporting the appreciation would likely be delayed due to the falling value of the Euro following the European sovereign debt crisis. However the renminbi remains managed and the new flexibility means it can move down as well as up in value; two months after the peg ended the renminbi had only appreciated against the dollar by about 0.

By January , the renminbi had appreciated against the dollar by 3. Treasury once again declined to label China a currency manipulator in their February report to Congress. However Treasury officials did advise the rate of appreciation was still too slow for the best interests of the global economy.

In February , Moody's analyst Alaistair Chan has predicted that despite a strong case for an upward revaluation, an increased rate of appreciation against the dollar is unlikely in the short term. While some leading surplus countries including China have been taking steps to boost domestic demand, these have not yet been sufficient to rebalance out of their current account surpluses.

By June , the U. With the US currently suffering from high unemployment and concerned about taking on additional debt, fears are rising that the US may resort to protectionist measures. By September , international tensions relating to imbalances had further increased. Brazil's finance minister Guido Mantega declared that an "international currency war" has broken out, with countries competitively trying to devalue their currency so as to boost exports.

Some economists such as Barry Eichengreen have argued that competitive devaluation may be a good thing as the net result will effectively be equivalent to expansionary global monetary policy. Others such as Martin Wolf saw risks of tensions further escalating and advocated that coordinated action for addressing imbalances should be agreed on at the November G20 summit. Commentators largely agreed that little substantive progress was made on imbalances at the November G An IMF report released after the summit warned that without additional progress there is a risk of imbalances approximately doubling to reach pre-crises levels by Balance of payments and international headcount data is critical to the formulation of national and international economic policies.

The balance of payments imbalances and foreign direct investment FDI is crucial for a country's policymakers to seek solutions. The impact of national and international policies can be seen in the balance of payments data. For example, one country may implement a policy to attract foreign investment. In contrast, another country may want to keep its currency relatively low to stimulate exports.

Although a country's balance of payments will bring its current account and capital account into balance, there will be imbalances between countries' accounts. Suppose a country's balance of payments deficits are persistent. In that case, the country may suffer from a loss of confidence as its foreign exchange reserves deplete. At the same time, it makes the country very vulnerable to seasonal, cyclical or unpredictable fluctuations in foreign countries.

It could lead to excessive inflation at home. Therefore, the stability of currency provides a strong guarantee for the sustainable development of the economy. Countries can analyze the current economic situation domestically and internationally through the annual balance of payment and formulate effective monetary policy combined with the political influence of international and multilateral relations Zolotas and Ethymiou The economic policy objectives could, in principle, serve as the standard for the balance of payments policies.

At the same time, exchange rate policy is treated as income policy. De Roos argues that only equilibrium of the balance of payments can be considered as a long term criterium for the balance of payments policy in the case of stable exchange rates. In the case of flexible exchange rates, the criterium can be found in the degree of domestic economic stability.

From Wikipedia, the free encyclopedia. Difference between the inflow and outflow of money to a country at a given time. Not to be confused with Balance of trade. Main article: Classical economics. Further information: Deglobalization. Main article: Bretton Woods system. Main article: Washington Consensus. Main article: Exchange rate regime. This section does not cite any sources. Please help improve this section by adding citations to reliable sources. Unsourced material may be challenged and removed.

March Learn how and when to remove this template message. Main article: Reserve currency. Main article: Currency crisis. Main article: Currency war. The Great Transformation. Beacon Press. ISBN John Ravenhill ed. Global Political Economy. Oxford University Press. The End of Globalization. Tragedy and Hope. ISBN X.

This would have an expansionary and possibly inflationary effect on their economies, helping to reverse the earlier trade surplus and thus correct the imbalance. However central banks of surplus countries could choice not to allow the extra gold to circulate in their domestic economies, hoarding it in their vaults, and thus the burden of rebalancing would fall entirely on the deficit countries which may need to deflate their economies in order to reduce prices and regain competitiveness.

Project Syndicate. Retrieved 19 May Inside International Finance. Retrieved 11 December Prasad; Raghuram G. Peterson Institute. Archived PDF from the original on 14 December Retrieved 15 December Fixing Global Finance. Yale University Press. Trade in Goods and Services — Balance of Payments thru ".

National Bureau of Economic Research. Moody's Analytics. Retrieved 23 February The Financial Times. Retrieved 10 January Princeton University Press. International Economics. Exchange Rates and International Finance 4th ed. Prentice Hall. International Financial Markets 3rd ed. Eun, Bruce G. Resnick International Financial Management. China Machine. University of Washington. Archived from the original PDF on 20 July Retrieved 5 July Archived from the original on 31 January Net , Stephanie Schoenwald: "Globale Ungleichgewichte.

Flassbeck" — via www.

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