The Balance of Payments: Linking the United States to the International Economy Open economy An economy that has interactions in trade or finance with other countries. Balance of payments The record of a country’s trade with other countries in goods, services, and assets. Current account The part of the balance of payments that records a country’s net exports, net investment income, and net transfers. Balance of trade The difference between the value of the goods a country exports and the value of the goods a country imports.
The Balance of Payments: Linking the United States to the International Economy The Current Account Trade Flows for the United States and Japan, 2006
The Balance of Payments of the United States, 2006 (billions of dollars) CURRENT ACCOUNT Exports of goods $1, 023 Imports of goods − 1, 861 Balance of trade − 838 Exports of services Imports of services Don’t forget net compensation of nationals working abroad (= Labor Services) The Balance of Payments balances: Current Account + Financial Account + Capital Account 423 − 343 Balance of services Income received on investments Income payments on investments 80 650 − 614 Net income on investments − 36 Net transfers − 90 Balance on current account − 812 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 Statistical Discrepancy BALANCE ON CAPITAL ACCOUNT = Statistical discrepancy ZERO Balance of payments 805 -4 11 0
The International Sector and National Saving and Investment U. S. Imports and Exports, 1970– 2006
Current account Records payments for currently produced goods and services, including capital and labor services. • Mostly exports and imports of goods and services. • Also includes net int’l earnings of country’s labor and capital resources. • Unilateral transfers (exports and imports not paid for) are netted out. Financial account The part of the balance of payments that records purchases of assets a country has made abroad and foreign purchases of assets in the country. Net foreign investment The difference between capital outflows from a country and capital inflows. Also equal to net foreign direct investment (fdi) plus net foreign portfolio investment. Capital account The part of the balance of payments that records relatively minor transactions, such as migrants’ transfers, and sales and purchases of nonproduced, nonfinancial assets.
The Foreign Exchange Market and Exchange Rates Currency appreciation An increase in the market value of one currency relative to another currency. Nominal exchange rate The value of one country’s currency in terms of another country’s currency. EXCHANGE RATE BETWEEN THE DOLLAR AND THE INDICATED CURRENCY Canadian dollar UNITS OF FOREIGN CURRENCY PER U. S. DOLLAR PER UNIT OF FOREIGN CURRENCY 1. 067 0. 937 Japanese yen 122. 650 0. 008 Currency depreciation A Mexican peso 10. 919 0. 092 decrease in the British pound 0. 507 1. 972 market value of Euro 0. 752 1. 330 one currency relative to another Some currencies have fixed exchange rates that do not currency. change over long periods. The country’s central bank buys and sells the currency at the fixed rate of exchange.
The Foreign Exchange Market and Exchange Rates: The Operation of Supply and Demand for a Currency Equilibrium in the Market for Foreign Exchange Foreign demand for US dollar: • Buy US stuff • Currently produced goods and services • Buy US assets • Stocks • Bonds • Real estate • Hotels and factories (fdi) • Hold $ in US banks • Transactions demand • Speculative demand
12 Month Average Unemployment by Category http: //www. nytimes. com/interactive/2009/11/06/business/economy/unemployment-lines. html? hp State and local rates: http: //www. bls. gov/Lau/
The Foreign Exchange Market and Exchange Rates: Shifts in Demands and Supplies An increase in the supply of An Increase in Supply of Dollars on Foreign dollars in exchange for yen: Exchange Market…Americans buy more • Americans buying more Toyota. Japanese cars…. cars • Americans buying more Toyota… and An Increase in Demand for Dollars: Japanese buy a lot more US bonds & hotels stock • Americans fearing dollar depreciation buy yen now. $ Depreciates (Get fewer yen/dollar) But a bigger Increase in the Demand for Dollars: • Japanese buying more US bonds • Japanese buying more US factories Dollar Appreciates on net
How Movements in the Exchange Rate Affect Exports and Imports If the economy is currently below potential GDP, then, holding all other factors constant including prices at home and abroad, depreciation of the domestic currency should increase net exports, aggregate demand, and real GDP. An appreciation in the domestic currency should have the opposite effect: Exports should fall, and imports should rise, which will reduce net exports, aggregate demand, and real GDP. It’s the real exchange rate, the nominal rate adjusted for prices, that matters: Real exchange rate The price of domestic goods in terms of foreign goods. Real exchange rate = [Yen/$] x [$/Bourbon]/[Yen/Suntory] = Suntory/Bourbon
The International Sector and National Saving and Investment U. S. Imports and Exports, 1970– 2006
Balance of Payment Arithmetic Current Account Balance + Financial Account Balance = 0 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) + NFI Private saving finances domestic and foreign investment and the government’s deficit Public Saving = Taxes – Gov’t Spending = Spublic = T – G National Saving = Private Saving + Public Saving S = Sprivate + Spublic S = [I + (G - T) + NX] + (T - G) = I + NFI A country that saves a lot has positive NX and invests abroad -NFI = I - Sprivate - (T - G) = (I - Sprivate) + (G - T) = - NX Twin Deficit: G-T up NX down
The Effect of a Government Budget Deficit on Investment The Twin Deficits, 1978– 2006
Why Is the United States the “World’s Largest Debtor”? Large current account deficits have resulted in foreign investors purchasing large amounts of U. S. assets.
Can the U. S. Current Account Deficit Be Sustained? Sustaining the Unsustainable U. S. trade-weighted exchange index: Major currencies.
Key Terms Balance of payments Net foreign investment Balance of trade Nominal exchange rate Capital account Open economy Closed economy Real exchange rate Currency appreciation Saving and investment equation Currency depreciation Speculators Current account Financial account
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