Unit 7 Notes - April 27th, 2016

The Balance of Payments: The measure of money inflows and outflows between the United States and the rest of the world.

·         Inflows are referred to as CREDITS

·         Outflows are referred to as DEBITS

·         Balance of Payments is divided into 3 accounts:

o   Current Account

o   Capital/Financial Account

o   Official Reserves Account

·         Whatever is purchased/sold appears twice on the Balance of Payments.

Current Account

·         Balance of Trade or Net Exports

o   Exports of goods/services – Imports of goods/services

o   Exports create a credit to the balance of payments.

o   Imports create a deficit to the balance of payments.

·         Net Foreign Income

o   Income earned by US owned foreign assets – Income paid to foreign held US assets

·         Net Transfers (tend to be unilateral)

o   Foreign aid = a debit to the current account.

Capital/Financial Account

·         Balance of capital ownership.

·         Includes the purchase of both real and financial assets.

·         Direct investments in the United States is a credit to the capital account.

·         Direct investments by US firms/individuals in a foreign country are debits to the capital account.

·         Purchase of foreign financial assets represents a debit to the capital account

·         Purchase of domestic financial assets by foreigners represents a credit to the capital account.

Relationship Between Current and Capital Account

·         Current Account and Capital Account should zero each other out.

·         That is… If the current account has a negative balance (deficit), the capital account should have a positive balance (surplus).

Official Reserves

·         The foreign country holdings of the US Federal Reserve System.

·         When there is a balance of payments surplus, the Fed accumulates foreign currency and debits the balance of payments.

·         When there is a balance of payments deficit, the Fed depletes its reserves of foreign currency and credits the balance of payments.

·         The official reserves zero out the balance of payments.

Active vs Passive Official Reserves

The US is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

Equations:

·         Balance of Trade = Goods Exports + Goods Imports

·         Balance on Goods & Services = (Goods Exports + Service Exports) + (Goods Imports + Service Imports)

·         Current Account = Balance on Goods & Services + Net Investments + Net Transfers

·         Capital Account = Foreign Purchases + Domestic Purchases