Money and the Balance of Payments

Tibor Scitovsky

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781315438900
• Edition: 1
• Topic: Economics
• Subtopic: Comparative Economics
• Index: Economics

This general introduction to the theory of money and of balance of payments adjustment was originally published in 1969. It was the first book to pay full attention to the theory of assets: the relation of the supply of assets to the demand for holding them and the significance of asset movements for balance of payments adjustment. Written in simple language and with brevity, the book is intended for the student with a general knowledge of economics and economic institutions, but with no specialised knowledge of these topics.

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Part B
The Balance of Payments

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Chapter 7
The national and international accounts

We begin with a discussion of the national and international accounts and their relation, because this seems the best introduction to the subject of balance-of-payments adjustment and balance-of-payments problems. To understand the national income accounts of a closed economy, one must start with the Keynesian identity between total receipts and total payments. The flow of total receipts equals the flow of total payments, because they are the same transactions looked at from different people’s points of view. One person’s payments are necessarily some other person’s (or persons') receipts; and when all the people who make payments and all those who receive them belong to the same closed economy, the sum total of everybody’s payments must necessarily equal the sum total of everybody’s receipts.

The sum total of all payments and of all receipts, however, are amorphous and meaningless aggregates, made up of too many different kinds of transactions. They can be reduced to the more meaningful aggregates of total expenditure on final goods and total receipts of income for services rendered, by omitting items that are irrelevant or involve double counting. In particular, one must subtract from total payments and receipts those connected with the transfer from one person’s ownership to another’s of assets already in existence; one must also subtract the transfer of part of a person’s income to another, made not in payment for services rendered (in which case it would be additional income), but merely to let him share in the fun or burden of spending it. Finally, to avoid double counting, transactions involving intermediate goods must also be subtracted, since their value is included in that of the final goods they enter. There remain, on the one side, payments for final goods and services, on the other, receipts of income for services rendered; and these are again identically equal, because each of the transfers and intermediate transactions subtracted involved both a payment and a receipt and so represented equal deductions from the payments and receipts sides. In a closed economy therefore one can deduce the equality of total expenditure on final output with total incomes earned from the identity of total payments and total receipts.

In the open economy, the total receipts of residents cease to equal the total payments of residents. The people who make the payments and those who receive them often do, but sometimes do not, belong to the same economy, which is why total receipts and total payments tend to move together but are not necessarily equal. This state of affairs, the tendency of receipts and payments to move in the same direction but without a tendency to equality, will be the subject matter of chapter 8. Here, we shall explore some of the formal relations between these magnitudes.

A. THE RELATION BETWEEN THE NATIONAL AND THE INTERNATIONAL ACCOUNTS

If we divide residents’ total receipts, R, and residents’ total payments, P, into their domestic and foreign components according to the domicile of the other party to the transaction; and if we remember the argument of the previous paragraphs, then it appears that domestic receipts and domestic payments must be identically equal, so that the following relation holds:

R − P = (R_d + R_t) − (P_d + P_f) = R_f − P_f = B,

where B denotes the balance of international payments. In the open economy, total receipts may differ from total payments, and their difference equals the difference between foreign receipts and foreign payments, also known as the country’s net balance of international payments.

We may again proceed from global aggregate receipts and payments to receipts of income and expenditure on final goods. If we divide asset transfers, income transfers, and transactions in intermediate goods, into their domestic and foreign components, and recall that receipts and payments are identically equal for each domestic transaction, then the domestic components of all these can be subtracted from both aggregate receipts and aggregate payments without changing the equality. The retention of foreign receipts and payments for intermediate goods, and their bracketing with foreign receipts and payments for all other goods, is as it should be; because, from the country’s own point of view, intermediate goods exported become final goods, intermediate goods imported become primary resources, and their inclusion in the national accounts involves no double counting. If then, we ignore for the moment foreign transfers of income as unimportant, we find that a country’s net balance of international payments is identically equal with the sum of the net balance between its income receipts and final expenditures and the net balance of its external transfers of assets.

The meaning of this identity is best seen if for a moment one assumes a zero net balance, first in the transfer of assets, and then between incomes and expenditures. When net asset transfers are nil, a country’s balance of payments will be favorable or unfavorable, depending on whether its inhabitants earn more than they spend or spend more than they earn. This equality is often cited by those who, to stress their disapprobation of an unfavorable balance of payments, equate this to the profligate habit of spending in excess of earnings. But this equality holds only in the special case when net asset transfers are nil. When one assumes instead equality between income earnings and final expenditures, then the net balance of international payments becomes equal to the balance between asset inflows and asset outflows. In other words, keeping expenditures within earnings is no guaranty against an unfavorable balance of payments, which will still arise if imported assets exceed in value those exported.

It is worth considering in this connection the meaning of asset transfers. In the domestic realm, asset transfers are considered so uninteresting and unimportant that we do not even collect statistics. After all, they change not the distribution of wealth but merely the form in which different people hold wealth. In international relations, the same asset transfers can be a major cause of payments disturbances. In particular, people’s desire to exchange domestic for foreign assets in their portfolios will create an unfavorable balance of payments even if current spending stays within current earnings.

The components of the balance of payments, as listed in official statistics, need not be discussed here in detail; but it may be useful to distinguish those that link the different concepts used in the national accounts and so bring into focus the relation between these and the international accounts. Starting out from national expenditure, one subtracts imports and adds exports of final goods and services in order to obtain the domestic product. In other words, the difference between domestic product and national expenditure equals the balance of trade—if this is defined as exports minus imports of not only goods but also final services.

Thanks to the Keynesian identity between payments and receipts, the value of the domestic product equals the national income generated inside the country; but to this one must add foreign incomes earned by people at home and subtract domestic incomes accruing to people abroad in order to obtain national income earned. Since incomes are payments and receipts for productive services rendered, the difference between national income earned and national expenditure equals the balance of trade in goods and services—with services this time including not only final but also productive services. If next, national income earned is augmented by transfer incomes from abroad and diminished by incomes transferred to abroad, one obtains national income available within the country. The difference between national income available and national expenditure equals the balance of payments on current account:

Y − E = T_d.

For some purposes it is useful to express this last equality in slightly different form. Writing national income available as the sum of consumption and saving (Y = C + S), national expenditure as the sum of consumption and investment (E = C + I), and the current account of the balance of payments as the difference between exports and imports broadly interpreted (T_d = X − M), the above equality becomes

S − I = X − M
or
S + M = I + X.

What used to be the equality of saving and investment in the closed economy becomes, in the open economy, the equality of the difference between saving and investment and the difference between exports and imports, or the equality between the sum of savings and imports and the sum of investment and exports. Just as in the closed economy, these equalities can be interpreted either as identities between statistically ascertainable ex-post quantities, or as equilibrium conditions between quantities interpreted in the ex-ante sense as planned or intended magnitudes.

B. THE BALANCE OF PAYMENTS

Since we do not regard as money the foreign currencies foreigners use for this purpose; and our currency is not money from their point of view, virtually every international transaction is barter for one of the parties concerned. The significance of barter is its equivalence to two monetary transactions: a sale and a purchase. If an American producer sells shirts to Brazil for cruseiros, he is engaging in barter: a sale of shirts and a purchase of what we shall call short-term claims on Brazil. If he sells the shirts for U.S. dollars, then it is the Brazilian importer who engages in barter; a purchase of shirts and a sale of short-term claims on the United States. Sometimes a person engages in barter of this type because he has simultaneously made the two separate decisions to buy the one commodity and sell the other. Mostly, however, people barter not because they want to but because it is unavoidable in international transactions and because they can engage in a complementary transaction, which, combined with the barter, turns this into a single monetary transaction. The American who sells shirts for cruseiros usually does so because he can sell these for dollars; and the Brazilian who buys shirts for dollars does it because he can buy the dollars for cruseiros. Virtually every international transaction is matched by a complementary transaction in the foreign exchange market where one currency is sold for another. For a study therefore of equilibrium and disequilibrium in the balance of payments, one may just as well concentrate on the market for foreign exchange.

If this were like a commodity market, where supply and demand are equated by price adjustment, we would have flexible exchange rates and no balance-of-payments problems. The foreign exchange market, however, does not operate this way; and we do not even know if it could, because it never has. An isolated country has occasionally had flexible exchange rates in a world where all other countries kept their exchanges fixed; but one cannot generalize from its experience to how a system of universally flexible exchange rates would operate. This remains therefore an untried experiment, advocated by a small but increasing number of professional economists and abhorred by most businessmen and bankers, who believe that the uncertainty flexible rates would bring to economic life would be too high a price to pay for the solution of balance-of-payments problems.

In most foreign-exchange markets, prices are stabilized. Today, most countries’ monetary authorities are pledged by international agreement (as signatories of the charter of the International Monetary Fund) to maintain the value of their currency in terms of foreign currencies within margins of one per cent on each side of parity. In the past, their pledge to buy and sell gold at a fixed price against domestic currency accomplished very much the same thing. In either case, price is kept stable by accommodating purchases and sales of gold and/or foreign currency, which are additional to the autonomous purchases and sales of gold and foreign currency by those who need or obtain it in the course of ordinary foreign transactions they engage in for profit.

Accommodating transactions are carried out first of all by the monetary authority, whose task it is to keep exchange rates stable, and which keeps a reserve of gold and/or foreign currencies with which to accomplish this. Moreover, once the monetary authority is committed, and known to be committed to keep exchange rates stable, others too may engage in accommodating transactions and hold reserves with which to do so. For example, commercial banks may, to accommodate their customers, hold foreign currency reserves and be willing to add to or draw down these reserves. Such changes in their reserves will be accommodating not only to their customers but also in the sense of helping to maintain exchange rates stable.

We can now define equilibrium in the balance of international payments as the equality between the autonomous supply of foreign currency and the autonomous demand for foreign currency. This is an equilibrium situation, whether there is a monetary authority pledged to keep exchange rates stable but not having to interfere to to achieve this, or whether exchange rates are flexible and their movement assures the equality. On this definition therefore, payments disequilibrium is the difference between autonomous supply and autonomous demand; and this can only come about if monetary authority offsets the difference with accommodating transactions, either to keep exchange rates stable or at least to keep them from moving as much as they would otherwis...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Original Title Page
• Original Copyright Page
• Preface
• Table of Contents
• Part A Money
• Part B The Balance of Payments
• Index