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American companies normally do not want foreign currencies to finance their operations, thus their expectation is for foreign investors to send them dollars. In this scenario, capital flows between countries show up in the capital account portion of the balance of payments. As more U. Put another way: it costs relatively more to exchange for U. The exchange rate for U. For example, an expansionary monetary policy might increase the supply of U.

The relationship between balance of payments and exchange rates described here exists only under a free or floating exchange rate regime. The balance of payments does not impact the exchange rate in a fixed-rate system, because central banks adjust currency flows to offset the international exchange of funds.

The world has not operated under any single rules-based or fixed exchange-rate system since the end of Bretton Woods in the s. International Monetary Fund. Your Money. Personal Finance. Your Practice. Popular Courses. Key Takeaways Balance of payments is the statement of a country's trade with other nations.

The relationship between balance of payments and exchange rates under a floating-rate exchange system will be driven by the supply and demand for the country's currency and all transactions taking place with other countries. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.

We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. 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. Archived from the original on 27 November Retrieved 13 January Current Account Deficit". March Retrieved 19 January Archived from the original on 30 September Retrieved 29 September Archived from the original on 9 May Retrieved 23 May Financial Times. Archived from the original on 15 April Retrieved 13 April People's Bank of China. Retrieved 18 September Fred Bergsten November Foreign Affairs. Archived from the original on 1 December Archived from the original on 30 April Retrieved 1 May Applied Economic Analysis.

S2CID The other two basic functions are to provide liquidity and to impart confidence. While during the Washington Consensus period fewer emphasis was placed on the need for balance, in the main a requirement for correction was still accepted, though many argued that governments should leave such correction to the markets.

Palgrave Macmillan. Developing countries in particular would often experience difficulties, though even advanced economies like Britain had issues, with Black Wednesday an example when she had insufficient reserves to counter the market. Archived from the original on 1 June Retrieved 12 January Archived from the original on 1 April International Monetary Fund. Retrieved 17 May Archived from the original PDF on 22 February Retrieved 1 December Sky News.

Retrieved 24 May Retrieved 23 September Archived from the original on 6 May Retrieved 29 January Archived from the original on 28 January Archived from the original on 11 January

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Balance of payment - Term 1 12th Macro Economics. Complete chapter in 1 video

The balance of payments (BOP) transactions consist of imports and exports of goods, services, and capital, as well as transfer payments, such as foreign aid and. The balance of payments (BOP) is the record of all international financial transactions made by the residents of a country. There are three main categories of. The balance of payments (BOP) is a statement of all transactions made between entities in one country and the rest of the world over a defined.