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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.
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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 Current Account
Trade Flows for the United States and Japan, 2006
Don’t forget net
compensation of nationals working
(= Labor Services)
The Balance of Payments
Current account Records payments for currently produced goods and services, including capital and labor services.
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.
Nominal exchangerateThe value of one country’s currency in terms of another country’s currency.The Foreign Exchange Market and Exchange Rates
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.
Some currencies have fixed exchange rates that do not change over long periods.
The country’s central bank buys and sells the currency at the fixed rate of exchange.
Equilibrium in the Market for Foreign Exchange
State and local rates: http://www.bls.gov/Lau/
An Increase in Supply of Dollars on Foreign Exchange Market…Americans buy more Japanese cars….
… and An Increase in Demand for Dollars: Japanese buy a lot more US bonds & hotels
(Get fewer yen/dollar)
Dollar Appreciates on net
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]
Current Account Balance + Financial Account Balance = 0
Current Account Balance = -Financial Account Balance
Net Exports = Net Foreign Investment … NX = NFI
The Twin Deficits, 1978–2006
Large current account deficits have resulted in foreign investors purchasing large amounts of U.S. assets.
Sustaining the Unsustainable
U.S. trade-weighted exchange index: Major currencies.
Net foreign investment
Nominal exchange rate
Real exchange rate
Saving and investment equation
Balance of payments
Balance of trade