Unit 7 - The Balance of Payment

Definition

• Measure of money inflows and outflows between U.S and the rest of the worlth (ROW)
• Inflow: credits
• Outflow: debits
• The balance of payment is divided into 3 account
• Current account
• Capital/Financial account
• Official reserves

Double Entry Bookkeeping

• Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice. 

Current Account

• Balance of trade and Net exports
• Export of goods/services - Imports of goods/services
• Export create credit
• Import create debit
•  

Net Foreign Income
Income earned by U.S owned foreign asset - income paid to foreign held U.S asset

Net Transfers
Foreign aid -> debit to current account

Capital/Financial Account

• The balance of capital ownership
• Includes the purchases of both real and financial assets
• Direct investment in the U.S is a credit to capital account
• Direct investment by U.S firms/individuals in a foreign country are debit to capital account
• Purchase of foreign financial assets represents a debit to the capital account

Relationship between Capital and Current Account

• The current account and Capital account should zero each other out
• If the current account has a negative balance (deficit), then the capital account should then ahve 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 payment deficit, the Fed depletes its reserves.

Active vs. Passive Official Reserve

• The U.S is passive in its use of official reserves. It doesn't seek to manipulate the dollar exchange rate
• The people's Republic of China is active in its use of official reserve. It actively buys and sell dollars in order to maintain a steady exchange rate with the U.S