Unit 7 B.O.P

Balance of Payment:

Measure of money inflows and outflows between the US and the Rest of the World

• Inflows are referred to as Credits
• Outflows are referred to as Debits

The balance of payments is divided by 3 accounts
      1. Current Account
      2. Capital/ Financial Accounts
      3. Official Reserves Accounts

Current Accounts:

·         Exports create credit and Imports create debit

• Balance of trade or net exports: Exports of Goods/ Services, Import of Goods and Services.
• Net foreign income: Income earned by US owned foreign assets and Income paid to foreign held US assets
• Net transfers (tend to be unilateral)

-       Foreign aid → a debit to current account

Capital/ Financial Accounts:

• The balance of capital ownership
•  Includes the purchase of both real and financial assets
• Direct investment in the US is a credit to the capital account
• Direct investment by US Firms/ individuals in foreign country are debits to capital accounts
• Purchase of foreign financial assets represents a debit to a capital account
• Purchase of domestic financial assets by foreigners represents a credit to the capital accounts

Relationship Between Current and Capital Accounts:

·         Current Account and Capital should zero each other out

·         That is…. If Current Account has a negative balance (deficit) then the Capital Account should have a positive balance (surplus)

Official Reserves: 

• Foreign currency holdings of US Federal Reserve System
• When there is a balance of payments surplus the FED accumulates foreign currency and debits balance of payments
• When there is a balance of payments deficit FED depletes its reserves of foreign currency and credits balance of payments
• Official Reserves 0 out the balance of payments0

Active VS Passive Official Reserves

• The US is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

Formulas:

Balance of Trade

Good Exports + Goods Imports

Balance of Goods and Services

(Goods Exports + Service Exports) + (Goods imports + Service Imports)

Current Account

Balance on goods and services + Net Investments and Net Transfers

Capital Account

Foreign Purchases + Domestic Purchases