Balance-of-Payments Concepts—What Do They Really Mean?

1 Format. Thesehearingsreflectagrowingconcerningov ernment,academia, ,thedebateshaveintensifiedlatelyas onehand,therehasbeenasurgeofinterestinwh athasbeencalledthemonetaryapproachtotheb alanceofpayments. Thisapproachtopayments transactions withinthismonetaryframework, ,theproblemsofinterpreting currentbalance-of-paymentsconceptshave furtherintensifiedasaresultoftheevolutio nofasystemoffloatingexchangeratesamongth eworld smajortradingcountriesandtherapidaccumul ationofinternationalreservesbythemembers oftheOrganizationofPetroleuniEx-portingC ountries(OPEC). discussion,someproposalsforthereformofth emethodofpresentingdatarelatingtointerna -tionaltransactionswillbemade,Thediscuss ionwillalludetothefollowingpropositions: 1)Thereis awidespreadmisunderstandingoftheforcesth atgiveriseto,andtheimpactof, )Thismisunderstandinghasledtoundueconcer nonthepartofpolicymakers,inducingcostlyr ecom-mendationsfortraderestrictions,cont rolsoncapitalmovements,andexportpromotio ninordertosolvebalance-of-paymentsandexc hangerate problems ) )Theabovepropositionsapplyunderbothfixed andfloatingexchangerates,However, WhatDoTheyReallyMean?

2 :Theauthoracknowledgesthehelpfulcomments onearlier ,ofcourse,blamelessforanyremainingerrors . Fora discussionofthisapproach, , AMonetaryViewoftheBalanceofPayments, thisReview(April1975), Themonetary ,the currentconventionalwisdominpaymentstheor y(theelasticitiesandabsorptionapproaches )isconcernedprimarilywiththebalanceoftra dealoneandassumesthateither thereareno monetarycon-sequencesassociatedwithinter nationaltransactionsOr,tntheextentthepot entialforsuch consequencesexists,theycan be andare ~areconfusinginthemselvesandbecausemanyo fthewaysinwhich balance -of-paymentsstatisticsarere-porte dhave beenmadecompletely obsoleteas are-sultoftheswitch,FUNDAMENTALMISUNDERS TANDINGT hefundamental misunderstanding , ,onemustrecognizethatthetransactionsreco rdedinbalance-of-paymentssta-tisticsbear thesamerelationshiptoforeignanddo-mestic monetarypoliciesas , balance -of-paymentssurplusesanddeficits andmovementsinexchangeratesare the resultof adisparity the disparityiscorrectedis ,however,whensuchadisparityexists,spendi ngunitsattempttodrawdown(buildup)theirmo neybalancesthroughthepurchase(sale) sodoingtheyincrease(decrease)

3 , at amini-mum,thecauseofthechangeinthequanti tyofmoneysuppliedrelativetothequantityde manded,the initialconditionsunderwhichthechangeoc-c urred, ,thepointisthatanexcesssupplyof ordemandformoneywillbe clearedthroughthemarketsfor goods,services, ,andlwhatiscrucialforanunder standingofthebalanceofpayments,inanopene conomy(oueinwhichthereareinternationaltr adeand capitaltransactions)themarketsthroughwhi chmoneybalancesareadjustedextendbeyondna tionalboundaries.~ Forathoroughdiscussionofthe , ChannelsofMonetan Jnllueuce:ASurvey, thisReview(Noveusber1974),pp. 8-26. Theexistenceoffreeinternationalmarketsfo rgoods,services, , AMone-taryViewoftheBalanceofPayments, ,forexample,thatthedomesticmonetaryautho ritiesincreasethemoneysupplyincountryj,w hichleadstoanincreaseinthedemandforgoods ,services,andsecuritiesin thatcountry. Anysuchin-creaseindomesticdemandwillresu ltinatendencyfor pricesofdomesticreal andfinancialassetsincountryjtorise,inthe shortrun, , spendingunitsincountrywill simultaneouslyreduce theirpurchasesofdomes-ticreal andfinancialassetsinfavorofforeignassets whiledomestic suppliersoftheseassetswillseektosellmore athomeandlessabroad,Atthesame time, ofthesefactorsworkinfavorof anincreaseinthedemandforimportsandadecre aseintiledemandforexportsincountryjPAdju stmentUnderaSmjsternofFixedJ/xchan~eRate sUnderasystemof fixedexchangerates, forrealandfinancialassetswillhecapturedi nthe balance -of-paymentsstatisticsasanoverall deficitinthetradeandcapitalaccounts.

4 Theforeignrecipientsofthesemoneybalances havetheoptionofconvertingthemintotheirow ncurrenciesattheirrespective centralbanks,Theseforeigncentralbankswil lthenpresentthebalances theyaccumulatethroughsuchconver-sions tothecentralbankincountryjinreturnforpri maryreserveassets. Sincetheseprimaryreserveassets are one of thecomponentsof acountry smone-tary base(andthusadeterminantof itsmoneysup-ply),theeffectof thistransactionwillbeadecreasein themoney supplyofcountryjbacktowardsitsinitiallev elandanincreaseinthemoneysuppliesofitssu rplustradingpartners.~terras impom ts and exports thepurchaseorsaleofdomesticassets (realandfinancial)inforeignmarkets,Forex ample, Adeficit inthetradeaccountreflectsanexchaisgeofmo aeybalancesforrealassets(goodsandservice s).Adeficit , fixedexchange rates,theprimarychannelbywhichinternatio naltrade-and capitaltransactionscanhaveanimpactonaggr egateeco-nomicactivityis via theinternationalreserveflowsdescribedabo veandtheirsubsequentimpactonthemoney supply(bothforeign anddomestic).

5 However,one isunabletogauge themagnitudeofthis impactbylookingateither ,the effects onaggregateeco-nomicactivityof a deficitinthemerchandisetradeaccountalone couldhepartiallyorfullyneutralizedby asituationarose,the negativeaggregatedemandef-fects resulting fromanincreaseinimportsofgoodswouldbepar tiallyorfullyoffset byaninflow ,therewouldbe nogainor loss ofinternationalreservesandthemoneysupply wouldnotbeaffectedbytheinter-nationaltra deand ,thecrucialbalance-of-paymentsconceptist hatwhich ,the Balance-of-Payments conceptwhichismostusefulas ameas-ureoftheimpactofinternationaltrans actionsonthedomestic economyis oneinwhichtheonlytransac-tionsconsidered belowtheline arethosewhichhaveaninfluenceondomestican d foreignmoneysupplies.~JULY1975 Henceforth, (goldandholdingsofforeigncurrencybalance s)andchangesinforeigndepositsatFederalRe serveBanks. FloatingExchangeRatesUnderasystemoffreel yfloatingexchangeratesthebalanceofpaymen ts(onamoneyaccountbasis)isalwaysinequili brium(totalimportsequaltotalex-ports)and thereare nomoneysupplychangesasso-ciatedwithforei gntransactions,Inthiscasethead-justmentt othe disparity between thesupplyofanddemandformoneyisaccomplish edbychangesindomesticpricesandexchangera tes (whichchangeconcomitantlywith,andaccommo date,the requiredmovementindomesticpricelevels).

6 Inordertoanalyzetheprocessbywhich there-quiredadjustmenttakesplaceunderfre elyfloatingexchangerates,it thequantitiesoffor-eignexchangesupplieda nddemandedareequal,andthusalsothelevelat which ,invalueterms,imnportssvillalwaysequalex portsandthereisnevereitherasurplusor adeficitintImebalanceofpayments (onamoneyaccountbasis). Withinthemonetaryapproachframeworktherea reotherchannelsthroughwhichinteruatiomma ltransactionscanhavean ,somechangesintheterms,oftradeandinthevo lusueoftradeandcapitalflowscanaffectthep roductive ,itshouldbenotedthatbothofthesechannelsr elatet9theconcept whichinterna-tionaltransactionscanhavean impactonaggregateeconomicactivityisthrou ghtheirimpactontheownershipofthetotalmon eystock,Forexample, (ascurrentlymeasured) ,1-lowever,thedistribution wouldbesignificantomslyifthevohsmeoffore ign-owned depositswaslargeandifthebehaviorpatterno fforeigndollarownersdifferedsignificantl yfrontthat ,asyet, ,theconsensusseen ,Foradiscussionoftheconcept ofadomesticallyownedmoneystock, andAnatolBalbach, Mensure-mentoftheDomesticMoney Stock, thisReciew(May1972),pp.

7 10-23.~ ,amidthereforeit waywecanobserveadifferencebetweencredits anddebitsistoPage16selectcertainitemsout ofthebalanceofpaymentsandcom-parecredits anddebits chosenbecausethenetofthetransactionsincl udedthereinissignificant, forsomereason,insignandamount,Accordingt ocurrentusage,animagi-narylineisdrawn throughthebalanceof paymentssothattheitemsselectedforasubset appear abovetheline andtheremaining itemsaresaid tobe belowtheline. Foramorethoroughdiscussionofstandardbala nce-of-paymentsstatisticspneseritation,s eeJohnPippenger, balance -of-Pay-nsentsDeficits:Measuremen tandInterpretation, thisReview(November1973), ~ Themoneyaccountcapturesthe ,theonly onesthataffectthemoney supplyarethosethataffectsousecomponentof themonetarybase, foreigncurrencybalances(primasyreses-s-e assets)andforeigndepositsatFederalRe-ser veBanksare theonlycomponentsoftlsemonetarybasethata reaffectedbyinternationaltransactions,th eentireim-pactofthesetransactionsonthemo ney supplycanbecap-turedbyobservingthechange sis,theseitems,Assuch,theuwneyaccountinc ludeschangesinonlythese ,vreturn totheprevious ,therewillbeanincreaseinthedemandforimpo rts(thedemandforforeignex-change)andadec reaseinthedemandforexports(thesupplyoffo reignexchange).

8 Underfreelyfloat-ingexchange rates,theinevitableconsequencewillhearis eintheexchangerate (thepriceofforeigncurrenciesintermsofthe domesticcurrency).tm Assuch,a riseintheexchangerateisthenaturalcon-seq uenceoftheexistingmoneystock balance -of-paymentsconceptforgaugingthei mpactofinternationaltradeandcapitaltrans actionsonthedomestic ,ex-changeratemovementsandmoneyaccountde ficitsandsurplusesaremerelypartoftheadju stnientmech-anismbywhichadisparity between aproblem,buttheythem-selves arenot the ,andthemoneyaccountdeficitsandsurplusesa nd exchangeratemovementsaremerelyamechanism bywhich the stemsfromthefailuretorecognizethe ,thebeliefiswidespreadthatdeficitsinthet radeaccountare bad because ,however,oneisunabletogaugetheim-pactofi nternationaltransactionsondomesticdemand byfocusingonthetradeaccountalone,Evenif atradeaccountdeficitisnotoffset byasurplusinthecapitalaccount,theresulta ntdeficitinthemoneyaccountmerelyreflects thefact thatthestockofmoneyexceedsthequantityofm oneydemanded.

9 Somehowthisdisparitymust fixedexchange rates,themoneystockwill hedecreased automaticallythroughtheoutfion asimilarfashion,mostconcern overthedepre-ciationof acurrencyinaregimeoffloatingexchanget Thatis,thedomesticcurrency\ 1975ratesis beliefiswidelyheld thatthedepreciationof a nation scur-rencyis acauseofdomestic contrary,depreciationsarenot thesource,butarethe thatis,becausethereexistsadisparity between thesupplyofanddemandformoneywhichmust ,theexcesssupplyofmoneyitselfwillresulti nanincreaseinthedemandfordomesticallysup pliedrealandfinancialassetsaswellasforfo r-eignexchange(thedemandforforeignsuppli esofrealandfinancialassets).Consequently ,allprices(thepriceofforeign exchangeincluded) ,the resultwillbeanincreaseinthedemandformone yasspend-ingunitsattempttomaintaintherea lvalueofthatproportionoftheir ,theoriginaldisparity between thedemandforandsupplyofmoneywill becorrectedvia a riseindomesticpricesandadepreciationinth eforeignvalueofthedomes-ticcurrency(aris einthepriceofforeignexchange).

10 Inviewoftheforegoinganalysis, balance -of- pay-mentsdeficitsandsurplusesandexchange rate move-mentsshouldnotbe viewedasevilsthatareto , ,inlightofthenatureoftheforceswhichgiver isetothem, theyare,inasense, , balance -of-paymentsdataarepresentedinca tegories composedofsimilartypesofinternationaltra nsactions(forexample,mer-chandise trade,long-termcapital,etc.)-Thetrans-ac tionsgroupedtogetherinanyparticularcateg oryaresimilarinthat,given theexistinginstitutionalframeworkwstluu whichtheyoccur,theforces givingriseto,andtheimpactof,themissuppos edtobesimilar. TotImeextentthatanyset ofgroupingsever\vasappropriateorinformat ionallyuseful,thisuseful-nesscanhegreatl ydiminishediftherearechangesintheforces whichgive rise to, ortheimnpactof,that SecExhibitIandTableIforan outlineofthegroup-ingscurrentlyesnployed inbalance emainderofthisarticle,Page17 FEDERALRESERVEBANK ,or ,giventhechangeswhichhaveoccurredinthefi eld ofinternationaltradeandfinanceintimelast fewyears,itwouldnotheatallsurprisingtofi ndthatsome smajortradingnationsfmomafixedtoafloatin gexchangerateregime andtimesurgeintheaccumulationof itsrelevancepriortothesechanges and,where appropriate, anet borrowerfrom,ornetlenderto,foreigncountr iesas (giftsand similarpaymnentsbyAmericangovernmentalun itsandprivatecitizenstoforeignresidents) ,alloftimetransactioimsrecordedabovethel ineinthisaccountrepresentthetransferofre alassets(goods andservices)