IPE. Module 1
VIDEO 2 - WHAT IS THE BALANCE OF PAYMENTS?........................................................................................... 1
VIDEO 3 – THE CURRENT ACCOUNT (CA) ......................................................................................................... 2
VIDEO 4 – THE FINANCIAL ACCOUNT (FA)........................................................................................................ 4
VIDEO 5 – RESERVES AND THE REST ................................................................................................................ 6
VIDEO 6 – IMPORTANCE AND CRITICISM ......................................................................................................... 9
Video 2 - What is the Balance of Payments?
• A balance of payments is a summary of all payments into and out of a country.
• These flows of payments are divided into different accounts (categories).
o The overall BoP is a summary of all these categories together.
Explaining the BoP with an example: North Korea
• North Korea wants to import food and medicine from another country because they
don’t produce enough.
• Question:
o How do they pay for it?
§ They can’t pay with Korean money.
o What they need is foreign exchange (forex).
§ Example of forex is the USD, the EURO, the GBP, the YEN, the CHF…
• How does a country get forex?
o Export stuff to the rest of the world; or
o Borrow / sell assets
• However, North Korean cannot borrow money and exports very little. So, how do
they balance their BoP?
o They get forex through smuggling drugs and other illicit ways
Deficit and surplus accounts
• North Korea is a country with a current account deficit.
o It imports more than it exports.
§ Other examples are the US, the UK…
• Germany and the Netherlands are examples of countries with a current account
surplus.
o They export more than they import.
o However, this may be problematic as well.
1
, § E.g. Germany has a lot of forex but they have nothing to do with it:
they may have tons of Chinese money that they can’t use in Germany.
• Surplus countries have to recycle their current account surplus. How?
o They invest forex in the rest of the world.
§ If Germany has a lot of US dollars, they can invest it in American
bonds, US debt…
• Therefore, both surplus countries and deficit countries face constraints:
o SURPLUS countries need to do something with their extra forex;
o DEFICIT countries need to find a way to get extra forex.
• That’s why the BoP matters: it gives countries the opportunity to buy and sell to the
rest of the world.
• On a conceptual level, the BoP is the tracking of payments into and out of a country.
Video 3 – The Current Account (CA)
• The current account records a nation's transactions with the rest of the world—
specifically its net trade in goods and services, its net earnings on cross-border
investments, and its net transfer payments—over a defined period of time, such as a
year or a quarter.
• Categories within the current account:
1. Goods (imports/exports)
2. Services (imports/exports)
3. Primary income
4. Secondary income
è When you add all of them together, you get the Current Account.
• They are divided into:
a) Credit à a payment that a country receives.
b) Debit à a payment that a country makes.
o 1. Goods
§ tangible objects.
§ Credit à Exports
§ Debit à Imports.
o 2. Services
§ Services that you are able to trade internationally, like education,
financial advisors…
§ Exporting services is particularly done by wealthier countries.
§ Credit à Exports
§ Debit à Imports.
2
,à emerging/developing countries that export a lot of goods usually are net-importers of
services.
o 3. Primary income
§ You are paying a factor of production (labour/capital) in which the
payment goes from country to another.
• Labour
o Payment form: usually salaries/wages…
§ E.g. a professor at the RUG that lives in
Germany. He has an income that crosses
borders and therefore must be included in the
BoP.
§ It is a credit for Germany (money is going into
Germany) and a debit for the Netherlands
(money is going out of the Netherlands).
• Capital
o Payment form: dividents (specific for stocks) and
interests…
§ E.g. you are a resident of the Netherlands and
you want to buy British bonds (that could pay
you interest).
§ Your capital goes from the Netherlands to the
UK.
§ The interest represents the payment on your
capital.
§ Since it is crossing a border, it needs to go in
the BoP.
§ The UK would have a debit in the interest.
§ The Netherlands would have a credit (collecting
the interest).
à When we talk about surplus countries, e.g. the Netherlands and Germany, we do not talk
about the government (‘s transactions); we talk about every single resident, person,
business within the country.
o 4. Secondary income
§ Secondary income usually is much smaller than primary income.
§ Secondary income is the income that you have already received that
you then pass on to someone else (Remittance à money gifts)
• In the Netherlands (and other surplus countries) there’s
always more debit than credit every year. Why?
• Because there’s a lot of people working there and then
sending money to their home countries (usually the poor
ones).
• E.g.:
3
, o A Spanish guy works in the Netherlands and earns a
salary there. He sends money back to Spain to his
family.
o That’s a debit (in secondary income) for the
Netherlands;
o That’s a credit (in secondary income) for Spain.
à CA = credit - debit
Video 4 – The Financial Account (FA)
• We have seen that: CA = credit – debit
• The financial account is: FA = assets – liabilities.
• Definition:
o If you are owed something à you have an asset (it is a claim on a foreign
country)
o If you owe something à you have a liability (that you will have to pay)
§ Assets are always matched by liabilities.
• E.g.:
o A citizen of the Netherlands buys a share of Disney (a U.S. company). That is
an asset for the Netherlands (and a liability for the U.S.)
• What are we interested in the FA?
o 1. Direct investment (assets & liabilities)
o 2. Portfolio investment (assets & liabilities)
o 3. Other investment (assets & liabilities)
• 1. Direct investment
o A direct investment is when you invest in a company and there’s a shift of
control of the firm:
à if you buy 51% of the shares of Disney you are making a direct investment.
o Presumption that a direct investment is of longer term and less volatile
compared to other investments:
§ if you buy 51% of a company you’re not gonna sell it the day after.
• 2. Portfolio investment
o Portfolio investment consists of many small investments. E.g., you don’t buy
51% of shares, you only buy one or two.
o Considered to be hot money, because it moves in and out of an economy
very quickly.
o If direct investments are more long term (if you buy 51% of a company you’re
not gonna sell it the day after), portfolio investments (a few shares of a
company) can be bought and sold even after 2 hours if there’s money to be
made.
è If countries are worried about capital inflows, they would rather see
people do direct investments rather than portfolio investments.
4
VIDEO 2 - WHAT IS THE BALANCE OF PAYMENTS?........................................................................................... 1
VIDEO 3 – THE CURRENT ACCOUNT (CA) ......................................................................................................... 2
VIDEO 4 – THE FINANCIAL ACCOUNT (FA)........................................................................................................ 4
VIDEO 5 – RESERVES AND THE REST ................................................................................................................ 6
VIDEO 6 – IMPORTANCE AND CRITICISM ......................................................................................................... 9
Video 2 - What is the Balance of Payments?
• A balance of payments is a summary of all payments into and out of a country.
• These flows of payments are divided into different accounts (categories).
o The overall BoP is a summary of all these categories together.
Explaining the BoP with an example: North Korea
• North Korea wants to import food and medicine from another country because they
don’t produce enough.
• Question:
o How do they pay for it?
§ They can’t pay with Korean money.
o What they need is foreign exchange (forex).
§ Example of forex is the USD, the EURO, the GBP, the YEN, the CHF…
• How does a country get forex?
o Export stuff to the rest of the world; or
o Borrow / sell assets
• However, North Korean cannot borrow money and exports very little. So, how do
they balance their BoP?
o They get forex through smuggling drugs and other illicit ways
Deficit and surplus accounts
• North Korea is a country with a current account deficit.
o It imports more than it exports.
§ Other examples are the US, the UK…
• Germany and the Netherlands are examples of countries with a current account
surplus.
o They export more than they import.
o However, this may be problematic as well.
1
, § E.g. Germany has a lot of forex but they have nothing to do with it:
they may have tons of Chinese money that they can’t use in Germany.
• Surplus countries have to recycle their current account surplus. How?
o They invest forex in the rest of the world.
§ If Germany has a lot of US dollars, they can invest it in American
bonds, US debt…
• Therefore, both surplus countries and deficit countries face constraints:
o SURPLUS countries need to do something with their extra forex;
o DEFICIT countries need to find a way to get extra forex.
• That’s why the BoP matters: it gives countries the opportunity to buy and sell to the
rest of the world.
• On a conceptual level, the BoP is the tracking of payments into and out of a country.
Video 3 – The Current Account (CA)
• The current account records a nation's transactions with the rest of the world—
specifically its net trade in goods and services, its net earnings on cross-border
investments, and its net transfer payments—over a defined period of time, such as a
year or a quarter.
• Categories within the current account:
1. Goods (imports/exports)
2. Services (imports/exports)
3. Primary income
4. Secondary income
è When you add all of them together, you get the Current Account.
• They are divided into:
a) Credit à a payment that a country receives.
b) Debit à a payment that a country makes.
o 1. Goods
§ tangible objects.
§ Credit à Exports
§ Debit à Imports.
o 2. Services
§ Services that you are able to trade internationally, like education,
financial advisors…
§ Exporting services is particularly done by wealthier countries.
§ Credit à Exports
§ Debit à Imports.
2
,à emerging/developing countries that export a lot of goods usually are net-importers of
services.
o 3. Primary income
§ You are paying a factor of production (labour/capital) in which the
payment goes from country to another.
• Labour
o Payment form: usually salaries/wages…
§ E.g. a professor at the RUG that lives in
Germany. He has an income that crosses
borders and therefore must be included in the
BoP.
§ It is a credit for Germany (money is going into
Germany) and a debit for the Netherlands
(money is going out of the Netherlands).
• Capital
o Payment form: dividents (specific for stocks) and
interests…
§ E.g. you are a resident of the Netherlands and
you want to buy British bonds (that could pay
you interest).
§ Your capital goes from the Netherlands to the
UK.
§ The interest represents the payment on your
capital.
§ Since it is crossing a border, it needs to go in
the BoP.
§ The UK would have a debit in the interest.
§ The Netherlands would have a credit (collecting
the interest).
à When we talk about surplus countries, e.g. the Netherlands and Germany, we do not talk
about the government (‘s transactions); we talk about every single resident, person,
business within the country.
o 4. Secondary income
§ Secondary income usually is much smaller than primary income.
§ Secondary income is the income that you have already received that
you then pass on to someone else (Remittance à money gifts)
• In the Netherlands (and other surplus countries) there’s
always more debit than credit every year. Why?
• Because there’s a lot of people working there and then
sending money to their home countries (usually the poor
ones).
• E.g.:
3
, o A Spanish guy works in the Netherlands and earns a
salary there. He sends money back to Spain to his
family.
o That’s a debit (in secondary income) for the
Netherlands;
o That’s a credit (in secondary income) for Spain.
à CA = credit - debit
Video 4 – The Financial Account (FA)
• We have seen that: CA = credit – debit
• The financial account is: FA = assets – liabilities.
• Definition:
o If you are owed something à you have an asset (it is a claim on a foreign
country)
o If you owe something à you have a liability (that you will have to pay)
§ Assets are always matched by liabilities.
• E.g.:
o A citizen of the Netherlands buys a share of Disney (a U.S. company). That is
an asset for the Netherlands (and a liability for the U.S.)
• What are we interested in the FA?
o 1. Direct investment (assets & liabilities)
o 2. Portfolio investment (assets & liabilities)
o 3. Other investment (assets & liabilities)
• 1. Direct investment
o A direct investment is when you invest in a company and there’s a shift of
control of the firm:
à if you buy 51% of the shares of Disney you are making a direct investment.
o Presumption that a direct investment is of longer term and less volatile
compared to other investments:
§ if you buy 51% of a company you’re not gonna sell it the day after.
• 2. Portfolio investment
o Portfolio investment consists of many small investments. E.g., you don’t buy
51% of shares, you only buy one or two.
o Considered to be hot money, because it moves in and out of an economy
very quickly.
o If direct investments are more long term (if you buy 51% of a company you’re
not gonna sell it the day after), portfolio investments (a few shares of a
company) can be bought and sold even after 2 hours if there’s money to be
made.
è If countries are worried about capital inflows, they would rather see
people do direct investments rather than portfolio investments.
4
