The Balance of Payments

The Balance of Payments - Measure of money inflows and outflows between the U.S. and the rest of the world (ROW)

• Inflow = Credit
• Outflow = Debit

• 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 practice

• Ex. U.S. manufacturer, John Deere, exports $50 mil worth of farm equipment to Ireland
• Credit of $50 mil to current account
• (- (minus) $50 mil worth of equipment/assets)
• Debit of $50 mil to capital financial account
• (+ $50 mil worth of euros or financial assets
• The two transactions offset each other. Theoretically, the balance payments should always equal zero

Current Account

• Balance of Trade or Net Exports
• Exports of goods/services - import of goods/services
• Exports create a credit to BOP
• Imports create a debit to BOP
• Net Foreign Income
• Income earned by US owned foreign assets
• Ex. Interest payments on US owned Brazilian bonds - interest payments on German owned US Treasury bonds

• Net Transfer (unilateral)
• Foreign aid ---> Debit to current account
• Ex. Mexican migrant workers send money to family in Mexico

Capital/Financial Account

• The balance of capital ownership
• Includes purchase of both real and financial assets

Relationship between Current and Capital Account

• The current account and capital account should zero each other out
• Current Account has negative balance (deficit), Capital Account should have positive balance (surplus)

Official Reserves

• The foreign currency holdings of the U.S. Fed
• When there is a balance of payments surplus the Fed accumulates foreign currency and debits the BOP
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the BOP
• Official Reserves zero out the BOP

Active v. Passive Official Reserves

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

• 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 U.S.