Def: A measure 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 payments is divided into three accounts:
- Current account
- Capital/financial account
- Official reserves account
Double entry bookkeeping:
-Every transaction in the balance of payments is recorded twice in
accordance with standard accounting practice.
Ex: US manufacturer john Deere exports 50 million worth of farm
equipment of Ireland
-A credit of 50 million to the current account
-Debit of 50 million to the capital financial account
-Notice that the two transactions offset each other(should
theoretically equal zero)
Current account :
-Balance of trade or net exports
Exports of goods services- imports of good/services
Exports create a
credit to the balance of payment
Imports create a debit of the balance of payments
-Net foreign income
Incomes earned by us owned foreign assets- income paid to foreign held
us assets
-Net transfers
Foreign aid-a debit to the current account
Ex: Mexican migrant worker send back money
Capital/financial account:
The balance of capital ownership: Includes the purchase of both real
and financial assets
-Direct investment in the U.S is a credit to the capital account
Ex: The Toyota factory in San Antonio
-Direct investment 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
Ex: Warren buffet buys stock in Petro china.
-Purchase of domestic financial assets by foreign represents a credit
to the capital account
Ex: The United Arab emirates sovereign wealth fund purchases at large
stake.
Relationship between current and capital account:
-The current account and the capital account should zero each other out
That is if the 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 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 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 with the U.S.
Balance of Trade:
Goods and services exports - goods and services imports
-Deficit- imports is greater than exports
-Surplus- exports is greater than imports
Unofficial way of calculating trade:
Goods exports + goods imports
Balance of goods and services:
Goods imports + service imports
Current account:
Balance of trade + net investment + net transfers
Capital account:
Foreign purchases of U.S assets + U.S purchases of assets abroad
Official reserve:
Capital account balance + current account balance
