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Macroeconomics: balance of payments accounts

  • Balance of payment is the sum of three separate accounts and must always be equal to 0 (given no statistical error):
    • Current account: the net flow of funds exchanged for goods and services, and monetary gifts  that flow in and out of a country. This is often used as an indicator for net export.
    • Financial account: also known as the capital account, is the net flow of funds for investment in real assets (direct investments) or financial assets (stocks or bonds) into a nation.
    • Official reserves: in order to balance the two accounts above, a country must have a reserve of foreign money. It measures the net effect of all money flows from the other accounts.
    • If the current account is positive, it must be the case that the sum of the financial account and official reserves is negative.
  • Current account (CA) components:
    • Balance of trade in goods: spending by consumers and firms on imported and exported goods. Exported goods have a positive effect on the current account, whereas imported goods have a negative effect.
    • Balance of trade in services: tourism, banking, transportation, etc... Domestic services bought by foreigners has a positive effect on CA, and foreign services have a negative effect.
    • Income balance: transfer of incomes earned by workers in one country to a foreign nation and vice versa. If part of a worker's income is sent to a relative in a different country, this has a negative effect on the CA.
    • Current transfer balance: transfer payment made by one nation to another, without an exchange of goods or services, or a person sending/receiving money to /from someone in a foreign country.
  • Positive CA is known as a trade surplus, it receives more payments in its current account from the rest of the world than it sends out, and Xn is positive (generally speaking, the last two components are relatively small). 
  • Negative CA is known as a trade deficit. A nation sends more money than it receives. Its net export variable is expected to be negative.
  • Financial account (FA) components:
    • Direct investments: when an entity acquires about 10 percent of company's ownership. If a domestic investors buy 10 percent of foreign company's ownership this has a negative effect on the FA. Positive effect when a foreign company acquires a domestic company.
    • Portfolio investment: just like direct investment but under 10 percent (mostly about stocks and bonds).
    • Other investments: loans made by banks. When a domestic bank lends money abroad this as a negative effect until the loan is payed back.
    • Note that the capital account is not exactly equal to the financial account. It only focuses on payments for capital expenditures/investments.
  • Official reserves account:
    • Foreign exchange reserves: assets of other nations held the domestic central bank. Consists mostly of foreign government bonds and foreign currency.
    • If the flow of money into the country from the current and financial accounts exceeds the flow of money out of the country, the difference is added to the foreign exchange reserves controlled by the central bank.
    • If the sum of the CA and FA accounts is negative, then there is a positive inflow of money (i.e the central bank must sell its foreign reserves in exchange for domestic money).
    • The foreign exchange reserves can be used to influence the exchange rate.
    • Here are the numbers for the U.S foreign exchange reserves
References:
  • The Federal Reserve Bank of St. Louis.
  • Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 237-245.

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Location: Boston, MA, USA

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