ECONOMICS, BALANCE OF PAYMENTS

Economics, Balance of Payments

Economics, Balance of Payments

Introduction

The balance of payments registers the international financial position of a country, using a double-entry bookkeeping approach to tabulate the market value of the transactions in goods, services, and financial assets between the country's residents and the residents of the rest of the world. Like gross domestic product (GDP), the balance of payments encompasses transactions in goods and services produced during the year, but, unlike the GDP, the balance also encompasses transactions in assets. In addition to categorizing international transactions as debits or credits, the balance of payments separates private transactions in goods and services into the current account and transactions in assets into the capital account. Official government transactions, undertaken to affect the exchange rate, are typically separated from private transactions in balance of payments accounting (Destler, 1990, 88).

Credits and Debits

As a result of the double-entry bookkeeping approach, every transaction appears on the balance of payments as either a credit or a debit. A transaction that involves a payment received from foreign residents, due to the international sales of goods, services, or assets by domestic residents, is a credit on a country's the balance of payments (Faust, 1989, 74). For example, when a German firm exports a product and receives a payment from a foreign resident, the value of the product appears on the Germany's balance of payments as a credit, with a positive sign, on the balance of payments account. Alternatively, if foreign residents purchase German's government bonds from a German bond dealer, the bond dealer receives a payment for the bonds, and this transaction also appears on the balance of payments as a credit.

The balance of payments classifies any transaction involving a payment to foreign residents as a debit. If a German resident buys a foreign automobile, for example, making payment to the foreign auto firm, the payment is a debit and appears on the balance of payments accounts with a negative sign.

Balance of Payments Transactions

Table 1 demonstrates the three methods for categorizing an international transaction illustrated by a German resident's purchase of a Japanese automobile for $25,000. The German resident completes the transaction by writing a check for $25,000, which the Japanese auto manufacturer then deposits in a German bank account.

The originating transaction, the purchase of the Toyota automobile, is an autonomous transaction, accommodated by the change in foreign (Japanese) holdings of German bank ...