Macroeconomics — Unit 7: Balance of Payments

📊 The balance of payments is an accounting report that records all economic transactions made between residents of the country and residents of the rest of the world during a given period, usually a year.

The report includes:
• Goods and services, imports and exports
• Investments and loans
• Unilateral transfers, such as gifts and donations
• Changes in foreign exchange reserves

It is different from the government budget and different from a central bank report.

🔄 The double-entry principle is a basic accounting principle.

Every transaction is recorded twice:
• Once on the debit side, representing an outflow of foreign currency
• Once on the credit side, representing an inflow of foreign currency

Example: Importing computers for $100 in cash:
• Import = $100 on the debit side
• Decrease in foreign exchange reserves = $100 on the credit side

Therefore, the balance is always balanced.

📤 The debit side records everything that causes an outflow of foreign currency from the economy:

• Imports of goods and services
• Investments abroad, such as residents buying shares or real estate abroad
• Loans to abroad
• Unilateral transfers abroad, such as gifts and donations abroad
• An increase in foreign exchange reserves, when the central bank buys dollars

Rule: Debit = money goes out.

📥 The credit side records everything that causes an inflow of foreign currency into the economy:

• Exports of goods and services
• Foreign investments in the economy, such as foreigners buying shares or real estate in Israel
• Loans from abroad
• Unilateral transfers to the economy, such as foreign aid and reparations
• A decrease in foreign exchange reserves, when the central bank sells dollars

Rule: Credit = money comes in.

📋 The balance of payments consists of three parts:

I. Current account:
• Goods and services, imports and exports
• Income from factors of production
• Unilateral transfers

II. Capital account:
• Investments, direct and financial
• Loans

III. Foreign exchange reserves:
• Changes in the central bank reserves

Together, the three parts always sum to zero.

🏭 Recording cash exports:

When goods are exported and payment is received in cash:

• Exports, credit: $50,000 — foreign currency enters in exchange for the goods
• Increase in foreign exchange reserves, debit: $50,000 — the dollars were added to reserves

An increase in reserves is recorded on the debit side because it represents the use of the foreign currency that entered.

Total debit = total credit = $50,000.

📦 Recording imports — part cash and part credit:

Debit:
• Imports = $100,000, the full value of the goods that entered

Credit:
• Decrease in foreign exchange reserves = $50,000, the part paid in cash
• Loan from abroad = $50,000, because the credit is a debt to the foreign supplier

Credit means a loan from abroad: the foreign supplier gave us credit.

Total debit = $100,000
Total credit = $50,000 + $50,000 = $100,000.

🎁 Recording a grant in goods:

A grant in goods means that goods were given without receiving payment.

Debit:
• Unilateral transfer abroad = $20 million, the gift that was given

Credit:
• Goods exports = $20 million, because the goods physically left the country

Even though it is a gift, the goods still left Israel and are therefore recorded as exports.

There was no cash flow, but the balance is still balanced because the two sides are equal.

💰 Recording investment abroad:

When Israelis invest abroad, foreign currency leaves the economy.

Debit:
• Investments abroad = $40 million, capital that left to buy shares

Credit:
• Decrease in foreign exchange reserves = $40 million, because the dollars left the reserves

Investment abroad = capital outflow = recorded on the debit side.
Foreign investment in Israel = capital inflow = recorded on the credit side.

🏦 Recording loan repayment plus interest:

Debit:
• Loan repayment, capital account = $4 million
• Interest payment, current account = $1 million

Credit:
• Decrease in foreign exchange reserves = $5 million

Important distinction:
• The loan principal belongs to the capital account
• Interest belongs to the current account, as income from factors of production

Both are recorded on the debit side because foreign currency leaves the economy.

📈 Calculating the current account balance:

Formula:
CA = exports - imports + net unilateral transfers

Calculation:
CA = 2,100 - 2,500 + 100
CA = -400 + 100
CA = -300 million dollars

A negative value means a current account deficit.

Meaning: the economy bought more from the world than it sold to it, even after including the gifts it received.

⚖️ The balance of payments identity:

CA + KA + ΔR = 0

Where:
• CA = current account balance
• KA = capital account balance
• ΔR = change in foreign exchange reserves

Calculation:
-300 + KA + 0 = 0
KA = +300 million dollars

If there is a deficit in the current account, there must be a matching surplus in the capital account, or a decrease in foreign exchange reserves, so that the balance of payments remains balanced.

🏦 Recording a foreign deposit in a local bank:

When a foreign resident deposits money in an Israeli bank, this is treated as a loan from abroad, because the bank owes money to the foreign depositor.

Credit:
• Loan from abroad = $8 million, foreign capital entered the economy

Debit:
• Increase in foreign exchange reserves = $8 million, the dollars were added to reserves

A foreign deposit in Israel = loan from abroad. An Israeli deposit abroad = loan to abroad.

🎖️ Recording receipt of equipment — part grant and part credit:

Debit:
• Equipment imports = $2 million, the full value of the equipment that entered

Credit:
• Unilateral transfer to the economy, grant = $1 million
• Loan from abroad, credit = $1 million

Grant = unilateral transfer, a gift.
Credit = loan, a debt that must be repaid.

Total: $2 million debit = $2 million credit.

📊 Calculating the current account balance:

Identify what belongs to the current account:

(1) Investments abroad $40 million = capital account, not current account.
(2) Interest paid abroad $20 million = current account, income from factors of production.
(3) Goods grant $20 million = unilateral transfer debit + exports credit:
• Unilateral transfer abroad = -$20 million
• Exports = +$20 million
• Net effect in the current account = 0

Calculation:
CA = 0 - 20 + 0 = -$20 million.

Note: According to the Hebrew answer marked in the source, the expected answer is $40 million, but the Hebrew explanation calculates only $20 million. This row requires source-data verification.

📉 The connection between the accounts and reserves:

According to the balance identity:
CA + KA + ΔR = 0

Therefore:
ΔR = -(CA + KA)

Examples:
• CA = -100, KA = +150 → ΔR = -50, reserves increase
• CA = -100, KA = +80 → ΔR = +20, reserves decrease
• CA = -100, KA = +100 → ΔR = 0, reserves do not change

If the capital surplus is larger than the current account deficit, reserves increase. If the capital surplus is smaller than the current account deficit, reserves decrease.

🔄 Calculating the change in reserves:

Current account:
CA = 200 - 250 + 30 = -20 million dollars, a deficit.

Capital account:
KA = 40 + 20 = +60 million dollars, a surplus.

Change in reserves:
ΔR = -(CA + KA) = -(-20 + 60) = -40

Negative ΔR means that reserves increased by $40 million.

Explanation: the capital surplus, 60, is larger than the current account deficit, 20, so more foreign currency entered than left, and reserves increased.

📋 Unilateral transfer:

This is a transaction in which one side gives something without receiving anything in return.

Examples:
• American aid to Israel, as a gift
• Reparations from Germany
• Donations abroad after a disaster
• Foreign workers’ wages sent to their country of origin

Even though there is no consideration in return, the transaction is still recorded twice.

Example: receiving cash aid:
• Unilateral transfer to the economy, credit
• Increase in foreign exchange reserves, debit

⚖️ Why is the balance always balanced?

Because of the double-entry principle.

Every transaction is recorded twice:
• Once as debit
• Once as credit

Therefore: total debit = total credit always.

Example: Importing $100 in cash:
• Import, debit = $100
• Decrease in reserves, credit = $100

This does not mean the economy is in good condition. It only means the accounting is correct.

📊 Calculating net loans:

Given:
• CA = -100 million dollars, deficit
• ΔR = 0, reserves did not change

From the balance identity:
CA + KA + ΔR = 0
-100 + KA + 0 = 0
KA = +100 million dollars

The capital account consists of:
KA = net investments + net loans
100 = 160 + net loans
Net loans = -60 million dollars

A negative value means that the economy gave net loans, meaning it gave more loans abroad than it received.