Unit 7

Unit 7

4-26-16

The Balance of Payments

-Measure of money that 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 3 accounts

1. Current Account
2. Capital/Financial Account
3. Official Reserves Account

-Double Entry Bookkeeping=Every Transactions in the balance of payments is recorded as a credit and a debit

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 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 in the United States is a credit to the capital account

-Ex. The Toyota Factory in San Antonio

-Direct investment by the U.S. firms/individuals in a foreign country are debits to the capital account

-Ex. The Intel Factory in San Jose, Costa Rica

-Purchase of foreign financial assets represents a debit to the capital account

-Ex. Warren Buffet buys stock in Petrochina

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

-Ex. The United Arab Emirates sovereign wealth fund purchases a large stake in the NASDAQ

-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 United States Federal Reserve System

-Then 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 United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange Rate.

Current now capital investment official reserves

Formulas

Balance of trade: Good exports + goods imports

Balance on goods & services: Goods exports + service exports + goods imports + service imports.

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

Capital account: Foreign purchases + domestic purchases.

Comparative advantage vs comparative advantage

Absolute

Individual/national

Exists when a person or a country can produce more of a certain good/service than someone else in the same amount of time or a country can in the same time period

Comparative

Individual/national

Exists when an individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation 

Input problems vs output problems

Input

Whichever country produces a certain amount of something by using the least amount of resources, land, or time has the absolute advantage

Chosen item/forgone item

Output

What is given up/what is produced