UNIT 7: Balance of Payments

Balance of Payments

Balance of Payments:

Measures of money inflows and outflows between the united states and the rest of the world (ROW)

- Inflows are referred to as credits

- Outflows are referred to as debits

The balance of payment is divided into three accounts:

1.      Current account

2.      Capital/financial account

3.      Official reserves account

Double entry book keeping:

Every transaction in the balance of payments is recorded twice in accordance.

                                              
Current account:

Balance of trade or Net exports

- Exports of goods/services- import of goods/services.

- Exports create a credit to the balance of payments.

- Imports create a debit to the balance of payments.

Net foreign income

- Income earned by the U.S. owned foreign assets

Net transfers (tend to be Unilateral)

-  Foreign aid- a debit to the current account.

-  EX/- Mexican migrant worker sends money to family.

                                           
Capital / Financial Account:

· The balance of capital ownership.

· Includes the purchase of both real and financial assets

· Direct investment in the United States is a credit to the capital account.
EX/ the Toyota company in San Antonio.

· Direct investment by United States firms/individuals in a foreign country are debits to the capital account.

· Purchase of foreign financial assets represents a Debit to the capital account. For example Warren buffets buys stock.

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

                                         
Relationship between current and capital account:

· Remember double entry bookkeeping?

· The current account and the capital account should zero each other out.

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

                                                     
Official reserves:

· The foreign currency holdings of the U.S. fed.

· 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.

Active v. passive official reserves:

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

-The People's Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate w/ the United States.

 
FORMULAS:

1.      Balance of trade:

         Good exports + goods imports

2.      Balance on goods & services :

          Goods exports + service exports + goods imports + service imports

3.      Current Account:
          Balance on goods and services + net investment + net transfers

4.      Capital account:

         Foreign purchases + domestic purchases