Curiosity 15.3: How Do We Know the Statistical Discrepancy?
In Table 15.1 the statistical discrepancy entry seems large. Big discrepancies are, m tact, quite common because the government is unable to monitor closely the movement of dollars across its borders. Cross-border shopping, for example, is not tracked accurately, and illegal cross-border activities can be of significant magnitude.
An interesting question here is how the international accounts statistician could possibly provide a measure of this statistical discrepancy. The reason is that the final figure for the balance of payments is known. The final figure is accurately measured by the net amount of buying or selling of foreign currency by the Fed, plus changes in foreign central bank dollar holdings in the United States. Thus, in order to measure the statistical discrepancy all that need be done is to subtract the sum of the current and capital accounts from total official transactions.
An unresolvable problem is that it cannot be known how much of the statistical discrepancy belongs to the current account and how much to the capital account. By tradition, it is included in the capital account on the belief that most hidden transactions take the form Of capital flows.
ance of payments surplus that is, an excess demand of $29 billion dollars on the foreign exchange market. This will be matched by a $29 billion excess supply of dollars by the central bank on the foreign exchange market. The central bank should accumulate $29 billion in foreign exchange reserves in meeting this excess demand for dollars. The official settlements account measures the accumulation of domestic dollars in the foreign exchange reserve account of the Fed and the change in dollar holdings held by foreign central banks in the United States. Central banks' demands for dollars are not included in the balance of payments because they do not represent free-market forces. The economist's concept of the balance of payments can be measured by the negative of the official settlements balance.
15.4 The Twin Deficits
An interesting aspect of the balance of payments accounts is that it is quite possible to have an economy in international equilibrium while simultaneously its subsidiary accounts are unbalanced, as long as they offset each other. The U.S. economy, for example, for several years had a current account deficit that was offset by a surplus in its capital account.
How might this situation come about? A prominent explanation is that it is a side effect of large government budget deficits hence termed the twin deficit problem. A large government deficit increases the interest rate as the government sells bonds to finance its deficit. This rise in the interest rate makes U.S. bonds look very attractive to overseas investors, so capital flows into the United States, creating a balance of payments surplus. This bids up the value of the dollar, which in turn decreases exports and increases imports, creating a balance of trade deficit. This process is illustrated in figure 15.1.
Readers with good memories might recall from chapter 6 that foreign financing can be used to supplement national saving. That is exactly what is happening here.
