Teaching why the Balance of Payments equals zero.

Hong Kong under the British had a quite sensible approach of not collecting any balance of payments statistics. The reason was was as soon as you start collecting these statistics, people would worrying about them.

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A HT to colleague Nick Lloyd for this great explanation of the relationship between the current account and the capital and financial accounts. In theory the balance of payments should equal zero and this is one area that students find hard to comprehend. Hope you find it as useful as I did.

The Relationship between the Current Account and the Capital and Financial Account

A few starting points:

  1. Gross Domestic Product (GDP) = C + I + G + (X – M)
  2. Gross National Product (GNP) = GDP plus Net Income (Income Credits (Yc) – Income Debits (Yd))
  3. Saving/Investment Gap (S – I) = Balance on Capital and Financial Account (Capital Outflows (Ko) – Capital Inflows (Ki))
  4. Current Account Balance = Trade Balance (X – M) + Net Income (Yc – Yd)
  5. National Savings = GNP – (Private Spending (C) + Government Spending (G))

Now:

GNP                                      =               GDP…

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