BALANCE OF PAYMENTS

-Measure of money inflows and outflows between the U.S. and the rest of the world.

 *Inflows are referred to as CREDITS.

 *Outflows are referred to as DEBITS.

-The balance of 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 and services – import of goods and services.

-Exports create a debit to the balance of payments.

Net foreign income

-Income earned by U.S. owned by foreign assets – income paid to foreign held U.S. assets.

Net transfers

-Foreign aid -> a debit to the current account.

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.

-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 the capital account should zero each other out.

-That is if the current account has a negative balance (deficit), then the capital account should have a positive balance (surplus).

OFFICIAL RESERVES

-The foreign currency holding 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 payment.

-When there is a balance of payment deficit, the FED depletes its reserves of foreign currency and credits the balance of payments.

-The official reserves zeros out the balance of payment.

ACTIVE VS PASSIVE OFFICIAL RESERVES

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