Unit 7

The Balance of Payment

• Balance of Payment
• 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 Payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of Goods/Services - Imports 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 U.S. owned foreign assets - Income paid to foreign held U.S. assets
• Ex. Interest Payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign Aid → a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico.
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets.
• Direct investment by U.S. 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
• The Current Account and 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 United States 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.
• Where there's a balance of payments the Fed depletes
• Active v. Passive Official Reserves
• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.