Lecture 1B: The balance of payments

Part B: why a country's external position matters

Think of a country like a household. If you spend more than you earn, you must borrow, and your debt grows. A country that buys more goods and services from abroad than it sells must borrow from foreigners (or sell them assets). The international accounts measure exactly this. For monetary policy it matters because foreign borrowing depends on interest rates and the exchange rate: a country that owes a lot to foreigners, especially in a foreign currency, is vulnerable to exchange rate and interest rate swings, which limits its central bank.

This part is mainly descriptive (what do the numbers look like?). Later the course asks why: why do countries borrow, can they do so forever, what determines their debt?

Global imbalances. A world map of current account balances added up over 1980-2017 shows deep red (big borrowers) and deep green (big lenders), not the white you would see if everyone were balanced. Largest cumulative deficit: the United States, $11.0 trillion. The lenders: Japan ($3.9 trillion), China ($3.3 trillion), Germany ($3.3 trillion) and oil and gas exporters. Top ten surpluses: Japan, China, Germany, Switzerland, the Netherlands, Russia, Saudi Arabia, Taiwan, Norway, Singapore.

The balance of payments: the country's bookkeeping with the world

The balance of payments records all transactions between residents of a country and the rest of the world. In the US the Bureau of Economic Analysis (BEA) keeps it, in the International Transactions Accounts (ITA). It has three parts:

1. Current account (CA): trade in goods and services, plus income and gifts across borders.
2. Financial account: purchases and sales of assets (shares, bonds, firms, loans) between residents and foreigners.
3. Capital account: a small item: capital transfers such as debt forgiveness or investment grants.

Why the accounts must balance. Every purchase must be paid for. Suppose an American buys a $1,000 phone from China, and China is paid in dollars that it uses to buy a US Treasury bond. The phone is a US import (current account −$1,000); the bond sold to China is a US capital inflow (financial account +$1,000). This gives the balance-of-payments identity:

• The CA tells you how much a country borrows from the world; the financial account how: selling bonds, shares, real estate or firms, taking loans, or using its official reserves. Two sides of the same coin.
• The capital account is tiny for the US, which is why people loosely say "the current account deficit equals net capital inflows". For Greece it is not tiny, because of EU funds.
• Statistical discrepancy: in theory the identity always holds, but the two sides are measured from different sources (customs, surveys, bank data), so they never match exactly. The gap is the statistical discrepancy. If it is large and always in the same direction, it usually signals unrecorded capital flows.

Component 1: the trade balance

The trade balance (TB) is exports minus imports of goods and services: TB = goods balance + services balance. Goods: cars, oil, wheat, textiles. Services: tourism, education, medical care, consulting. A negative TB is a trade deficit, a positive one a trade surplus.

An export does not have to travel. A foreign tourist paying for a hotel in Greece counts as a Greek export of services: the buyer comes to the seller.

Is a deficit big or small? Divide by GDP. US 2020: exports $2.1 trillion, imports $2.8 trillion, so TB = −$0.7 trillion. GDP was $20.9 trillion, so TB/GDP = −0.7/20.9 ≈ −3%. Over time the US trade balance fell from a small surplus (about +0.75% of GDP) to −6% just before the 2007-2009 crisis, then recovered to about −3%, where it has stayed.

Components 2 and 3: income and transfers

• Income balance (in EU statistics: primary income) = income received from abroad minus income paid abroad. Mostly net investment income (NII): interest, dividends and profits on foreign investments. Plus a small part for wages of cross-border workers (net international payments to employees).
• Net unilateral transfers (in EU statistics: secondary income) = gifts received minus gifts given, with nothing in return. Examples: migrants sending money to family back home (remittances), foreign aid, EU budget contributions, pensions paid abroad. For the US this is negative.

Why the CA matters: a negative CA means the country's net debt to the world rises; a positive CA means it falls. The CA is a flow (borrowing this year); net foreign debt is a stock (what is owed today).