Understanding Balance of Payments: Accounts, Curves, and Mobility

Balance of Payments

The Balance of Payments (BP) is the systematic record of all economic transactions between the residents of a country and the rest of the world. It consists of two primary accounts:

Current Account

This account tracks trade in goods and services, as well as unilateral transfers. The current account shows a surplus when the income from exports and transfer payments exceeds the value of imports and net transfers to foreigners.

Capital Account

This account records the purchase and sale of financial assets, including stocks, bonds, land, and bank deposits. A surplus occurs when income from the sale of these assets to foreigners exceeds the payments made for the purchase of foreign assets.

The BP Curve

The BP curve represents the various combinations of income levels and interest rates that achieve equilibrium in the balance of payments, defined by the equation: BP = CA + CK = 0.

Construction of the BP Curve

The BP curve typically slopes upward because:

• Higher income levels increase imports, which worsens the current account.
• To offset this, interest rates must rise to attract short-term capital, thereby improving the capital account.

Points to the right of the BP curve indicate a deficit, while points to the left indicate a surplus.

Slope of the BP Curve

The positive slope depends on the sensitivity of the private capital account to changes in interest rates. The greater the sensitivity of capital to interest rates, the flatter the BP curve becomes.

Types of Capital Mobility

• Perfect Capital Mobility: The BP curve is horizontal, indicating that the domestic interest rate equals the world interest rate (i = i*).
• Imperfect Capital Mobility: Capital flows are sensitive to interest rate differentials, but not perfectly elastic.
• Perfect Capital Immobility: The BP curve is vertical, indicating that barriers prevent capital movement regardless of interest rate changes.

Movements of the BP Curve

The BP curve shifts due to variables affecting the balance between the current and capital accounts, including:

• Domestic and world prices
• Autonomous exports
• Exchange rates
• World income levels
• World interest rates

Factors Causing Shifts

• Increases in: Domestic prices, world interest rates, autonomous exports, exchange rates, global income, and world prices.

Simultaneous Equilibrium

The interaction between the real sector, the monetary sector, and the balance of payments is analyzed using the IS-LM-BP model.