Deficit and surplus in the balance of payments:

The conventional focus is on three main imbalances that may occur within the balance of payments. The first is  the current account andfor  the trade account.  

The basic balance is defined as  the sum of  the current account balance and the net balance on long-term capital, which were then seen as the most  stable elements in  the balance of payments,  and  so placed 'above the  line'.  A worsening of the basic balance (an  increase in a deficit or a reduction  in a surplus, or even a move  from  surplus to deficit) was  seen as  indicating  a deterioration in the (relative) state of the economy.

An alternative approach is to cgnsider whether the net monetary transfer that has  been made  by the  monetary  authorities  is  positive  or  negative -  the so-called settlements concept. If  the net transfer is negative (i.e.  there is an outflow)  then the balance of payments is said  to be in deficit, but if there  is an inflow then it is in surplus. The basic premise is that the monetary authorities are the ultimate financiers of any deficit in the balance of payments (or the recipients of any surplus). These official settlements are thus seen  as  the accomhodating  item, all others  being autonomous.

The monetary authorities may finance a deficit by depleting their reserves of foreign currencies, by borrowing from the IMF, or by borrowing from foreign monetary authorities. The latter source is of particular importance when other monetary authorities hold the domestic currency as part of  their own reserves.

A country whose currency is  'used as a reserve currency (such as the United States) may be able to run a deficit in its balance of payments without either depleting its own  reserves or borrowing from  the IMF  since  the  foreign authorities may be prepared to purchase that currency and add it to their own reserves. The settlements approach is mbre relevant under a system of pegged exchange rates than when exchange rates are floating.