Unit 7 - Balance of Payments

The Balance of Payments

• measure of money inflows and outflows between the U.S. 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 entryBook Keeping

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

Current account

•• Balance of Trade or Net Exports

•• Net foreign income 

•• Net transfers (tend to be unilateral)

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 

•• Direct investment by U.S. Firms, individuals in a foreign country are debuts to the capital account...

•• Purchase of foreign financial assets represents a debt 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. federal reserve system. 

• When there is a balance of payments surplus. The fed accommodates 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.