Chapter 09 e book chapter 21

The Balance of Payments, Exchange

Rates, and Trade Deficits
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International Transactions
• International trade
• Buy/sell current goods or services
• Imports and exports
• International asset transactions
• Buy/sell real or financial assets
• Buy stock
• Sell your house to a foreigner
• Requires currency exchange

LO1 21-2
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Balance of Payments
• Sum of international financial transactions
• Current account
• Balance on goods and services
• Net investment income
• Net transfers
• Balance on current account

LO2 21-3
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The balance of payments is the sum of all international financial transactions taking place between the
a nation’s residents and the residents of foreign nations. These transactions primarily fall into either
international trade or international asset exchange categories. In the U.S., the Commerce
Department’s Bureau of Economic Analysis compiles a balance-of-payments statement each year. It is
organized into two main categories: the current account and the capital and financial account.

The current account summarizes U.S. trade in currently produced goods and services. Exports are
a plus and imports are a minus. In 2015, the balance of goods was negative $760 billion which
represents a trade deficit. Looking at services, there was a surplus of exports over imports, leaving a
balance of positive $219 billion.
Also included in the current account is net investment income which represents the difference
between (1) the interest and dividend payments foreigners paid U.S. citizens and companies for
services provided, and (2) the interest and dividends the U.S. citizens and companies paid for the
services provided by foreign capital invested here. In 2015 the U.S. net investment income was a
positive $191 billion.
The final component of the current account is net transfer, both public and private. This includes
foreign aid, retirement funds paid to U.S. citizens living abroad, and money sent by immigrants
back to their native country. In 2015 that was a negative $136 billion. Adding it all up, the current
account in 2015 was a negative $486 billion. This means we had more money going out than coming
in.

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Balance of Payments Continued
• Capital and financial account
• Capital account
• Financial account
• Balance of payments accounts sum to zero
• Current account deficits generate asset transfers to foreigners
• Official reserves US bought from china goods worth = -$2500
China bought from US = +$1000
Balance in the current account of the US = -1500

China bought 1500 worth US bonds = +1500

Balance on cap and financial account = 1500

BOP =sum of Current and Capital & Financial Account=

-1500+1500=0
LO2 21-5
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The second component of the balance of payments summarizes the international asset transactions.
The capital and financial account consists of the capital account, which mainly measures debt
forgiveness, and the financial account, which deals with international purchases and sales of real
or financial assets. The capital account had a $0 balance in 2015, which indicates that the U.S. forgave
exactly as much loans to other countries than other countries forgave in our loans. In the financial account,
the balance was a positive $486 billion, which is not necessarily a good thing, as it indicates we sold
more of our real and financial assets to foreign investors than they sold to us.

Satisfying demand for foreign currency is not as easy. Here, the central bank must hold foreign currency
on hand since it cannot legally print a foreign currency. The foreign currency held by the central bank
is part of the official reserves.

The official reserves not only consist of stockpiles of foreign currencies but also include bonds issued
by foreign governments, gold reserves, and special reserves held at the International Monetary
Fund.

The stockpiles of foreign currencies are referred to as foreign-exchange reserves, or, less formally, FX
reserves.

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 1513-2273= -760

Balance of Payments Concluded

For instance
represents th
710-491=219 and dividend
citizens and
-760+219= -541 by U.S. capi
capital) and
U.S. citizens
-541+191-136=- provided by
486 (“imported”

Us bought from
china = $300 billion The capital a
forgiveness—
the person fo
China bought from IOU back to
US = $100 billion (one that can
listed in line
forgave exac
Balance for US to Americans a
them by fore
pay back ? = 300- 11 would ind
100 =200 billion “on-paper” i
amount of d

Balance of payments will

always balance. The
balance on the current
LO2
account equals the 21-7
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Balance of Payments Concluded
For instance
represents th
and dividend
citizens and
by U.S. capi
capital) and
U.S. citizens
provided by
(“imported”

The capital a
forgiveness—
the person fo
IOU back to
(one that can
listed in line
forgave exac
Americans a
them by fore
11 would ind
“on-paper” i
amount of d

LO2 21-8
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U.S. Trade Balances

LO2 21-9
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 International transactions fall into what two broad categories?

A. manufacturing trade and services trade

B. international trade and international asset transactions
C. currency transactions and services trade
D. newly created assets and preexisting assets

"International trade" refers to

A. purchasing or selling currently produced goods or services across an international border.

B. any transaction across an international border.
C. any financial transaction across an international border.
D. buying or selling of preexisting assets across an international border.

Which of the following would call for in payments to the United States?

A. Gold flows into the United States.

B. U.S. firms sell insurance to Brazilian shippers.
C. The United States sends foreign aid to developing countries.
D. The United States imports German automobiles.
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A foreign firm may buy a real asset, say an office tower in the United States or a U.S. government
bond.
[Both kinds of transactions involve the “export” of the ownership of U.S. assets from the United
States in return for payments of foreign currency (money “capital”) inflows.]

A. This is recorded as a positive flow in the financial account

B. This is recorded as a positive flow in the capital account
C. This is recorded as a negative flow in the financial account
D. This is recorded as a negative flow in the capital account

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Flexible Exchange Rates
The Market for Foreign Currency
(Pounds)
P
S1
Dollar Price of 1 Pound Exchange
$3
Rate: $2 = £1
Dollar
Depreciates
(Pound
Appreciates)
$2
Dollar
Appreciates
(Pound
Depreciates)
$1

D1
0
Q1 Q
Q1
Quantity of Pounds
LO3 21-12
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Flexible Exchange Rates Determinants
• Factors that shift demand/supply
1 big mac = AED 30
• Changes in tastes I big mac = $6

• Relative income changes Exchange rate = 30:6

30/6=
• Relative price-level changes
5:1
• Purchasing-power-parity theory 1 $ = 5 AED
• Relative interest rates
• Relative
• Speculation
• expected returns on assets
LO3 21-13
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Flexible Exchange Rates Disadvantages
• Volatility
• Uncertainty and diminished trade
• Terms-of-trade changes
• Instability

LO3 21-14
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Fixed Exchange Rates
• Government intervention
• Elimination of foreign exchange market
• Official reserves used to maintain rate
• Trade policies
• Exchange controls and rationing
• Domestic macroeconomic adjustments

LO4 21-15
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Fixed Exchange Rates Continued

LO3 21-16
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Fixed Exchange Rates Concluded

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(1) US Goods Exports +$100
(2) US Goods Imports −80
(3) US Service Exports +40
(4) US Service Imports −90
(5) Net Investment Income +20
(6) Net Transfers −15
(7) Foreign Purchases of Assets in the United States +30
(8) US Purchases of Foreign Assets Abroad -10
(9) Balance on Capital Account +5

The table contains hypothetical data for the 2016 U.S. balance of payments. All figures are in
billions of dollars. The United States has a balance of goods

A. deficit of $10 billion.

B. surplus of $30 billion.
C. deficit of $30 billion.
D. surplus of $20 billion.

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(1) US Goods Exports +$100
(2) US Goods Imports −80
(3) US Service Exports +40
(4) US Service Imports −90
(5) Net Investment Income +20
(6) Net Transfers −15
(7) Foreign Purchases of Assets in the United States +30
(8) US Purchases of Foreign Assets Abroad -10
(9) Balance on Capital Account +5

The table contains hypothetical data for the 2016 U.S. balance of payments. All figures are in billions of
dollars. The U.S. balance on goods and services is a

A. $10 billion deficit.

B. $20 billion deficit.
C. $30 billion surplus.
D. $30 billion deficit.

21-19
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(1) US Goods Exports +$100
(2) US Goods Imports −80
(3) US Service Exports +40
(4) US Service Imports −90
(5) Net Investment Income +20
(6) Net Transfers −15
(7) Foreign Purchases of Assets in the United States +30
(8) US Purchases of Foreign Assets Abroad -10
(9) Balance on Capital Account +5

The table contains hypothetical data for the 2016 U.S. balance of payments. All figures are in
billions of dollars. The U.S. balance on current account is a

A. $40 billion surplus.

B. $25 billion deficit.
C. $25 billion surplus.
D. $30 billion deficit.

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(1) US Goods Exports +$100
(2) US Goods Imports −80
(3) US Service Exports +40
(4) US Service Imports −90
(5) Net Investment Income +20
(6) Net Transfers −15
(7) Foreign Purchases of Assets in the United States +30
(8) US Purchases of Foreign Assets Abroad -10
(9) Balance on Capital Account +5

The table contains hypothetical data for the 2016 U.S. balance of payments. All figures are in billions of
dollars. Item 6 indicates that

A. the United States used $15 billion of its international monetary reserves to balance its international
payments.
B. the United States provided $15 billion of foreign aid to developing nations.
C. Americans provided a net amount of $15 billion in remittances to the rest of the world.
D. Americans received a net amount of $15 billion in remittances from the rest of the world.

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(1) US Goods Exports +$100
(2) US Goods Imports −80
(3) US Service Exports +40
(4) US Service Imports −90
(5) Net Investment Income +20
(6) Net Transfers −15
(7) Foreign Purchases of Assets in the United States +30
(8) US Purchases of Foreign Assets Abroad -10
(9) Balance on Capital Account +5

The table contains hypothetical data for the 2016 U.S. balance of payments. All figures are in
billions of dollars. The United States' balance on financial account is a

A. $20 billion surplus.

B. $15 billion surplus.
C. $30 billion deficit.
D. $20 billion deficit.

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(1) US Goods Exports +$100
(2) US Goods Imports −80
(3) US Service Exports +40
(4) US Service Imports −90
(5) Net Investment Income +20
(6) Net Transfers −15
(7) Foreign Purchases of Assets in the United States +30
(8) US Purchases of Foreign Assets Abroad -10
(9) Balance on Capital Account +5

The table contains hypothetical data for the 2016 U.S. balance of payments. All figures are in
billions of dollars. The United States' balance of capital and financial account is a

A. surplus of $5.
B. deficit of $10.
C. surplus of $25.
D. deficit of $5.

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The current account section in a nation's balance of payments includes

A. its goods exports and imports and its services exports and imports.
B. foreign purchases of domestic assets.
C. purchases of foreign assets.
D. all of these.

A nation's capital and financial account

A. contains in payment items but not out payment items.

B. includes service exports and service imports.
C. includes both inpayments and outpayments.
D. includes net investment income and net transfers

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