The Balance of Payments

• Measuring money of inflows and outflows between the United States and the rest of the world.

• Inflows are referred 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

- Double Entry Bookkeeping

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

- Current Account

• Balance of trade or Net Exports

 - Exports of goods and services-imports of goods and 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 US owned foreign assets- income foreign held US Assets

- Capital/Financial Account

• The balance of capital ownership

• Includes the purchase of both real and financial assets

• Direct investment in the US is a credit tot he capital account

• Direct investment by US firms/individuals in foreign country are debits to the capital account

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

• Purchase of domestic financial assets by foreigners reprints a credit to the capital account. 

- Relationship between Current and Capital Account

• The current account and the capital account should zero each other out.

- Official Reserves

• The foreign currency holdings of the United States 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 of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.

- Active v. Passive Official Reserves

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

• The People’s Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States.