Unit 7
The Balance of Payments
· Measures of money inflows and outflows between the united states and the rest of the world (ROW).
The balance of payment is divided into three accounts:
1. Current account
- 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 create a credit to the balance of payments.
- Imports create a debit to the balance of payments.
- Net foreign income
- Interest payments on U.S. owned foreign assets- Interest payments on German-owned U.S treasury bonds.
- Net transfers (tend to be Unilateral).
- Foreign aid- a debit to the current account.
- Example- 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.
- For example the Toyota company in San Antonio.
- · Direct investment by United States firms/individuals in a foreign country are a debit to the capital account.
- Intel factory construction in Germany
- · 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
· 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.
For some unknown reason, I've always had a huge problem with telling the difference between a current and capital account. Fortunately, after reading your blog I could clearly see that current account deals with import and exports including net transfers and foreign income. On the other hand capital accounts deals with the purchases of assets and investments made in foreign countries and in the U.S.
ReplyDeleteYou've got a neat and well organized blog!
The formulas really help. Especially when finding the current account, which requires the equation on balance of goods and services.
ReplyDeleteGreat notes, it helped me have a better understanding between capital and current accounts! A good example of current/debit is when the US Treasury pays interest to holders of bonds in other countries.
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