International Finance

Third edition

by Keith Pilbeam

Chapter 2 - The Balance of Payments

Jump to Revision Questions for chapter 2

Chapter Introduction
In this chapter we look at one of the most important economic indicators for policymakers in an open economy, namely, the balance of payments. What is happening to a country’s balance of payments often captures the news headlines and can become the focus of attention. A good or bad set of figures can have an influential effect on the exchange rate and can lead policy-makers to change the content of their economic policies. Deficits may lead to the government raising interest rates or reducing public expenditure to reduce expenditure on imports. Alternatively, deficits may lead to calls for protection against foreign imports or capital controls to defend the exchange rate.

Before considering various policy options that may be devised to deal with perceived problems in the balance of payments, we need to consider in some detail exactly what the balance of payments figures are and what is meant by the notion of a balance of payments surplus or deficit. In this chapter, we shall look at what is contained in the balance of payments statistics, how they are compiled and at various possible economic interpretations of the statistics. We also look at how the current account of the balance of payments can be interpreted within the framework of the national income accounts and the effects of changes in governments’ expenditure and exports on the balance of payments.

Revision Questions
  1. Explain the difference between the current account, the capital account and the balance for official financing. Discuss why in theory the sum of the three accounts should be equal to zero.
  2. You are told that a country is running a current account deficit equivalent to $10 billion. Discuss what factors that you will need to consider before deciding whether this deficit is a policy problem.
  3. Do the record United States current account in 2006 of $800 billion matter? What are the possible mechanisms by which the deficit could be reduced?
  4. There is not necessarily any linkage between current account deficits and fiscal deficits. Discuss with reference to the USA and Japan or any two other OECD economies.
  5. "A current account deficit is not necessarily a bad thing." Discuss this statement.