Balance-of-Payments Accounting and the Foreign-Exchange Market

Abstract

There are two distinct concepts of the balance of payments which must not be confused: the market balance of payments, and the accounting balance of payments. The market balance of payments refers to the balance of supply and demand for a country’s currency in the foreign-exchange market at a given rate of exchange. If the exchange rate is fixed, the market balance of payments would be in balance only by chance. If it is not in balance and the exchange rate must be maintained, the monetary authorities would have to intervene to achieve balance by buying their own currency with foreign exchange if the home currency were in excess supply or by selling their own currency for foreign exchange if the home currency were in excess demand. If the exchange rate is allowed to float freely, however, the market balance of payments must always balance because the exchange rate is the price which equates the supply and demand for a currency in the foreign-exchange market.