Post on 29-Dec-2015
The Balance of Payments: Linking the United States to the International Economy
• Current account records a country’s net exports, net income on investments, and net transfers... That is, payments for currently produced goods and services including labor services (paid wages) and capital services (paid “investment income”)
• Balance of merchandise trade (sometimes called “balance of trade”)
• Balance of trade in goods and service
Balance of payments The record of a country’s trade with other countries in goods, services, and assets.
• Financial account records a country’s sales of domestic asset to foreign residents and purchase of foreign assets by domestic residents.
• Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment.
The Balance of Payments of the United States, 2008 (billions of dollars)
The Current Account
Trade Flows for the United States, 2006
U.S. Imports and Exports, 1970–2006
FINANCIAL ACCOUNT
Increase in foreign holdings of assets in the United States 1,860
Increase in U.S. holdings of assets in foreign countries −1,055
Balance on Financial Account 805
BALANCE ON CAPITAL ACCOUNT -4
Statistical discrepancy 11
Balance of payments 0
So how do we pay for the excess of current account payments
to foreigners over what they pay to US?
We sell them our IOUs and other assets (stocks, bonds, real estate deeds)
Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment, FDI, (in “factories”) plus net foreign portfolio investment (stocks and bonds).
• The “Balance of Payments” (BoP)is always zero (statistical discrepancy makes it so)
• Sometimes BoP refers to net private transactions in goods, services, and assets (China’s “BoP” surplus Bank of China buys US bonds)
Exchange Rates in the Financial Pages
http://www.bloomberg.com/markets/currencies/fxc.html
That was then…this is now
The Foreign Exchange Market and Exchange Rates
1 Foreign firms and households who want to buy goods and services produced in the United States.
2 Foreign firms and households who want to invest in the United States either through foreign direct investment — buying or building factories or other facilities in the United States — or through foreign portfolio investment — buying stocks and bonds issued in the United States.
3 People doing international business transacted in dollars.
3 Currency traders who believe the value of the dollar will increase.
Sources of demand for the U.S. dollar:
Sources of supply of the U.S. dollar are analogous: US residents
who want to buy foreign stuff or paper or hold foreign currencies
Equilibrium in the Market for Foreign Exchange
Currency appreciation An increase in the market value of one currency relative to another currency.
Currency depreciation A decrease in the market value of one currency relative to another currency.
How Do Shifts in Demand and Supply Affect the Exchange Rate?
1 Changes in the demand for U.S.-produced goods and services and changes in the demand for foreign-produced goods and services
2 Changes in the desire to invest in the United States and changes in the desire to invest in foreign countries
3 Changes in the expectations of currency traders about the likely future value of the dollar and the likely future value of foreign currencies
Factors that cause the demand and supply curves in the foreign exchange market to shift:
How Do Shifts in Demand and Supply Affect the Exchange Rate?
Adjustment to a New Equilibrium
Shifts in the Demand and Supply Curve Resulting in a Higher Exchange Rate
Some Exchange Rates Are Not Determined by the Market
Some currencies have fixed exchange rates that do not change … until they
are forced to: a payments deficit drains Central Bank foreign exchange
holdings; Ms declines; i rises capital inflows; Y and P fall Im decline
Balance of Payments balances at the fixed exchange rate.
• For economy below potential GDP, real depreciation/devaluation of the currency should increase net exports, aggregate demand, and real GDP.
• Real appreciation/revaluation of the domestic currency should have the opposite effect .
How Movements in the Exchange Rate Affect Exports and Imports
The Foreign Exchange Market and Exchange Rates
Real exchange rate The price of domestic goods in terms of foreign goods.
Domestic price levelReal exchange rate = Nominal exchange rate ×
Foreign price level
Some international monetary arithmetic
Current Account Balance + Financial Account Balance = 0
or:
Current Account Balance = -Financial Account Balance
or:
Net Exports = Net Foreign Investment … NX = NFI
Private Saving = National Income – Consumption - Taxes
Sprivate = Y – C – T = (C + I + G + NX) - C - T = [I + (G - T) + NX]
• Private saving finances domestic and foreign investment and a government deficit
Public Saving = Taxes – Gov’t Spending = Spublic = T – G
National Saving = Private Saving + Public SavingS = Sprivate + Spublic
S = [I + (G - T) + NX] + (T - G) = I + NFI
Capital In = - NFI= I - S=I - Sprivate - (T-G)= (I - Sprivate) + (G - T)
The Effect of a Government Budget Deficit on Investment
The Twin Deficits, 1978–2006
Why Is the United States Called the “World’s Largest Debtor”?
Makingthe
Connection
Large current account deficits have resulted in foreign investors purchasing large amounts of U.S. assets.
Exchange Rate: Can the US Current Account Deficit be Sustained?
Balance of payments
Balance of trade
Capital account
Closed economy
Currency appreciation
Currency depreciation
Current account
Financial account
K e y T e r m s
Net foreign investment
Nominal exchange rate
Open economy
Real exchange rate
Saving and investment equation
Speculators