5.

1 Balance of Payments Accounting

• Any transaction that involves a flow of funds into the United States is
a credit item and is entered with a plus sign; any transaction that
involves a flow of funds out of the United States is a debit item and is
entered with a minus sign. We illustrate this principle as we discuss
the various components of the balance of payments accounts
5.1 Balance of Payments Accounting
The Current Account

• The current account measures a country’s trade in currently produced

goods and services, along with unilateral transfers between countries.
For convenience we divide the current account into three separate
components:
(1) net exports of goods and services
(2) net income from abroad
(3) net unilateral transfers
5.1 Balance of Payments Accounting
The Current Account

• Net Exports of Goods and Services

• We discussed the concept of net exports, NX, or exports minus
imports, as part of the expenditure approach to measuring GDP in
Chapter 2. Here we point out that net exports often are broken into
two categories: goods and services
5.1 Balance of Payments Accounting
The Current Account
• Net Income from Abroad
• The income receipts flowing into a country, which are credit items in the current account,
consist of compensation received by residents working abroad plus investment income from
assets abroad. Investment income from assets abroad includes interest payments, dividends,
royalties, and other returns that residents of a country receive from assets (such as bonds,
stocks, and patents) that they own in other countries. For example, the interest that a U.S.
saver receives from a French government bond she owns, or the profits that a U.S. company
receives from a foreign subsidiary, qualify as income receipts from abroad.
• The income payments flowing out of a country, which are debit items in the current account,
consist of compensation paid to foreign residents working in the country plus payments to
foreign owners of assets in the country. For example, the wages paid by a U.S. company to a
Swedish engineer who is temporarily residing in the United States, or the dividends paid by a
U.S. automobile company to a Mexican owner of stock in the company, are both income
payments to residents of other countries
5.1 Balance of Payments Accounting
The Current Account
• Net Unilateral Transfers.
• Unilateral transfers are payments from one country to another that
do not correspond to the purchase of any good, service, or asset.
Examples are official foreign aid (a payment from one government to
another) or a gift of money from a resident of one country to family
members living in another country. When the United States makes a
transfer to another country, the amount of the transfer is a debit item
because funds flow out of the United States. A country’s net unilateral
transfers equal unilateral transfers received by the country minus
unilateral transfers flowing out of the country.
5.1 Balance of Payments Accounting
The Current Account
• Current Account Balance
• Adding all the credit items and subtracting all the debit items in the
current account yields a number called the current account balance. If
the current account balance is positive—with the value of credit items
exceeding the value of debit items—the country has a current
account surplus. If the current account balance is negative—with the
value of debit items exceeding the value of credit items—the country
has a current account deficit.
5.1 Balance of Payments Accounting
The Capital and Financial Account
• International transactions involving assets, either real or financial, are recorded
in the capital and financial account, which consists of a capital account and a
financial account. The capital account encompasses unilateral transfers of assets
between countries, such as debt forgiveness or migrants’ transfers (the assets
that migrants take with them when they move into or out of a country). The
capital account balance measures the net flow of assets unilaterally transferred
into the country.
• The capital and financial account balance is the sum of the capital account
balance, the financial account balance, and the net international flow of financial
derivatives. Because the capital account balance and the net international flow
of financial derivatives of the United States are so small, the capital and financial
account balance is almost equal to the financial account balance.
5.1 Balance of Payments Accounting
The Capital and Financial Account
• The Official Settlements Balance
• The official settlements balance also called the balance of payments is
the net increase (domestic less foreign) in a country’s official reserve
assets. A country that increases its net holdings of reserve assets
during a year has a balance of payments surplus, and a country that
reduces its net holdings of reserve assets has a balance of payments
deficit.
5.1 Balance of Payments Accounting
The Relationship Between the Current Account
and the Capital and Financial Account
• The Relationship between the Current Account and the Capital and
Financial Account.
• The logic of balance of payments accounting implies a close relationship
between the current account and the capital and financial account.
Except for errors arising from problems of measurement, in each period
the current account balance and the capital and financial account
balance must sum to zero. That is, if
• CA = current account balance and KFA = capital and financial account
balance,
• Then CA + KFA = 0.
5.1 Balance of Payments Accounting
Net Foreign Assets and the Balance of
Payments Accounts
• The total value of a country’s net foreign assets can change in two
ways: (1) the value of existing foreign assets and foreign liabilities can
change, as when stock held by a U.S. citizen in a foreign corporation
increases in value or the value of U.S. farmland owned by a foreigner
declines; and (2) the country can acquire new foreign assets or incur
new foreign liabilities.
5.2 Goods Market Equilibrium in an Open
Economy
• Let’s begin with the open-economy version of the condition that
desired national saving equals desired investment. In Chapter 2 we
derived the national income accounting identity (Eq. 2.9)

• If for simplicity we assume that net factor payments, NFP, are zero,
the current account equals net exports and the goods market
equilibrium condition, Eq. (5.3), becomes
5.2 Goods Market Equilibrium in an Open
Economy
• Equation (5.4) is the form of the goods market equilibrium condition that we will
work with. Under the assumption that net factor payments are zero, we can refer
to the term NX interchangeably as net exports or as the current account balance.
• As for the closed economy, we can also write the goods market equilibrium
condition for the open economy in terms of the aggregate supply and aggregate
demand for goods. In an open economy, where net exports, NX, are part of the
aggregate demand for goods, this alternative condition for goods market
equilibrium is
 5.2 Goods Market Equilibrium in an Open
Economy

Equation (5.6) states that in goods market equilibrium the amount of net exports a country sends abroad equals
the country’s total output (gross domestic product), Y, less total desired spending by domestic residents, Cd + Id +
G. Total spending by domestic residents is called absorption. Thus Eq. (5.6) states that an economy in which
output exceeds absorption will send goods abroad (NX > 0) and have a current account surplus and that an
economy that absorbs more than it produces will be a net importer (NX < 0), with a current account deficit.
5.3 Saving and Investment in a Small Open
Economy
5.3 Saving and Investment in a Small Open
Economy
5.3 Saving and Investment in a Small Open
Economy
5.3 Saving and Investment in a Small Open Economy
The Effects of Economic Shocks in a Small Open Economy
5.3 Saving and Investment in a Small Open Economy
The Effects of Economic Shocks in a Small Open Economy
5.4 Saving and Investment in Large Open
Economies