why BOP = 0 always? (1 Viewer)

[deviation]

Why does the BOP always = 0?

 

[shannonm]

Hi
I dont do economics but I did a search for you on google.com

Originally posted by deviation
Why the balance must equal zero. The BOP covers all trade in goods, services, and financial assets between nationals and foreigners over a given period, say, a year. By construction, the balance always sums to zero. In part, this is pure convention: it results from the practice of double-entry bookkeeping. Everything enters twice in the accounting, once as a positive item and another time as a negative item. But there is also some logic behind the zero-sum of the BOP. The logic relates to the fact that the BOP records not only the trade in goods, services, and interest-bearing financial assets, but also trades of home and foreign money. When trade of a non-money good for money takes place between nationals and foreigners, there are necessarily some associated changes in holdings of foreign money at home or home money abroad. The BOP takes into account all those changes in money holdings as well as the trade in goods. It is this simultaneous consideration of the sale or purchase of goods and the associated movement of money holdings that results in the zero balance

From http://www.google.com.au/search?q=c.../PDF/329~jm1.doc+economics+BOP&hl=en&ie=UTF-8

Hope that helps

 

[timmii]

Check this thread

 

[Bambul]

Shannonm's answer is actually the correct answer, or atleast the logical one. Don't write it down in an exam because YOU WILL GET IT WRONG. You must give the floating exchange rate theory, even though it doesn't explain why countries with a peg have a zero balance too (except for China, whose CAS and C/FAS are due to dodgy numbers).

 

[something]

yah - get rid of the post.. it will confuse all the ecos candidates.

 

[meep]

under a floating exchange rate, the BOP will always equal 0 because the exchange rate will automatically change to remove the differences between the current account and the capital and financial account
if I remember correctly, i think a pegged exchange rate is where the RBA has some intervention?
correct me if Im wrong

however if it is, it should have no effect on the zero balance

 

[Aj10001]

Nah you guys are confusing him/her. I did HSC economics last year and the reason why the BOP always equals 0 is because:

The Balance of Payments is comprised of 2 accounts: the current account (trade for goods and services mainly) and the capital account (borrowing and lending between countries). It is known that:

Surplus on Capital Account + Deficit on Current Account = 0

This is because any increase in the trade deficit must be countered by an increase in borrowings to pay for the deficit. Eg australia's trade deficit is $42 (which is shown as negative), it must borrow $42 (which is shown as positive) to pay for the trade debt.

 

[AGB]

Originally posted by Aj10001

Surplus on Capital Account + Deficit on Current Account = 0

This is because any increase in the trade deficit must be countered by an increase in borrowings to pay for the deficit. Eg australia's trade deficit is $42 (which is shown as negative), it must borrow $42 (which is shown as positive) to pay for the trade debt.

your theory is quashed when there is a trade surplus...

 

[Turner]

AGB, in countries where there is a surplus in the current account, that country purchases debt and equity with the extra from the current account surplus (and trade surplus). Btw I think Aj10001 is confusing trade balance with the Current Account Balance, which are two separate things.

 

[Lainee]

LOL, you know what? I thought I understood this all pretty well until I read this and got all confused.

I read shannonm's post and I was like - yeah, I get that. And then I read Bambul's and was like - so, shannonm's one is right but I can't write that in an exam but must write about some floating exchange rate thingy which only works in some instances. And then I read Aj10001's and I was like - okay, that's understandable. And then.... argh! *facepalms*

Can someone summarise all this into one all-round answer please?

 

[AGB]

Here is the theory on why the BOP always = 0

Supply of $A
Payments for imports (M)
Income/transfer debits (Y debits)
Capital and financial outflow (K outflow)

Demand for $A
Receipts for exports (X)
Income/transfer credits (Y credits)
Capital and financial inflow (K inflow)

Supply of $A = Demand for $A
M + Y debits + K outflow = X + Y debits + K inflow
M X + Y debits Y credits = K inflow K outflow (rearranged equation)
Balance on Current account = Balance on Capital and Financial account

hope this clears it up for you Lainee

 

[Turner]

Originally posted by Lainee
LOL, you know what? I thought I understood this all pretty well until I read this and got all confused.

I read shannonm's post and I was like - yeah, I get that. And then I read Bambul's and was like - so, shannonm's one is right but I can't write that in an exam but must write about some floating exchange rate thingy which only works in some instances. And then I read Aj10001's and I was like - okay, that's understandable. And then.... argh! *facepalms*

Can someone summarise all this into one all-round answer please?

The BOP == 0 under a floating exchange rate. You don't need to know why. Just accept it if you don't want to get confused.

That's what my teacher told me

 

[Turner]

Originally posted by AGB
thats not necessarily true...

Really. Why not?

 

[Newbie]

AGB is right on the money


turner
i think you need to know why its equal to zero
im sure i've seen a question somewhere ....

 

[rukawasan]

shit... u guys are pretty quick... i didnt figure this out til mid lastyr

 

[Lainee]

Originally posted by AGB
Here is the theory on why the BOP always = 0

Supply of $A
Payments for imports (M)
Income/transfer debits (Y debits)
Capital and financial outflow (K outflow)

Demand for $A
Receipts for exports (X)
Income/transfer credits (Y credits)
Capital and financial inflow (K inflow)

Supply of $A = Demand for $A
M + Y debits + K outflow = X + Y debits + K inflow
M X + Y debits Y credits = K inflow K outflow (rearranged equation)
Balance on Current account = Balance on Capital and Financial account

hope this clears it up for you Lainee

Can you explain what you mean by Supply and Demand for $A and why they have to be equal? I'm sorry, I'm particularly dense today, perhaps you should spell it out for me.

 

[AGB]

under a floating regime, the exchange rate is determined by the forces of supply and demand...have a look at the diag attached...

previous to the floating of the dollar, the BOP did not always = 0. however, when the dollar was floated, the BOP = 0 (due to the theory in the last post)

 

[Lainee]

But why do Payments for imports (M), Income/transfer debits (Y debits)and Capital and financial outflow (K outflow) make up the supply of $A? And the others the Demand for $A?

 

[AGB]

Originally posted by Lainee
But why do Payments for imports (M), Income/transfer debits (Y debits)and Capital and financial outflow (K outflow) make up the supply of $A? And the others the Demand for $A?

the factors that influence the demand for AUDs are the demand for exports and capital inflow, whereas the supply for AUDs is determined by the demand for imports and capital outflow

 

[Lainee]

Riiiighhht, get it. I'll leave the exchange rate thing until I get up that chapter in my textbook, I'll probably understand it better then. Thanks heaps AGB! (LOL, I'm probably going repeat your explanation word for word if I ever get that question in an exam.)