1) Balance of Payments - A record of all transactions between households, firms and the government of one country and the rest of the world
a) current account - trade balance + net transfers + net interest income
i) trade balance = exports - imports. Exports +, imports - ii) net tranfers - gifts between countries. Gift to US +, gift to other countries - iii) net interest income - income you receive from coupon payments (bonds) and dividends (stocks). US recieves (+), US gives (-)
b) Capital account - measures real asset flows (purchases of stocks, bonds, real estate, etc)
Foreign purchase of a US asset (+)
US purchase of a foreign asset (-)
c) reserve account - account that automatically balances out the BOP, measures official reserves
Foreign government purchase of USD (+)
US Fed purchase of foreign (-)
Basically, anything that would increase the demand for US dollars is a plus for the BOP, anything that would require selling of US dollars would be a negative.
II) USD appreciation/depreciation
a) Fed policy - If the Fed raises interest rates, the return on bonds goes up and this makes holding US dollars more attractive, all else equal. The reverse also holds true
b) Demand for US assets (appreciation)
c) demand for US goods (appreciation)
d) demand for foreign assets (depreciation)
e) demand for foreign goods (depreciation)
What is the Balance of Payments?
The balance of payments (BOP) records all of the many financial transactions that are made between consumers, businesses and the government in the UK with people across the rest of the World. The BOP figures tell us about how much is being spent by British consumers and firms on imported goods and services, and how successful UK firms have been in exporting to other countries and markets. It is an important measure of the relative performance of the UK in the global economy. At AS level we focus only on one part of the balance of payments accounts. This section is known as the current account. We will go through the make-up of this account in a later section.
Trade in goods
Trade in goods includes exports and imports of oil and other energy products, manufactured goods, foodstuffs, raw materials and components. Until recently this was known as visible trade – i.e. exporting and importing of tangible products.
What does a current account deficit mean?
Running a sizeable deficit on the current account basically means that the UK economy is not paying its way in the global economy. There is a net outflow of demand and income from the circular flow of income and spending. The current account does not have to balance because the balance of payments also includes the capital account. The capital account tracks capital flows in and out of the UK. This includes portfolio capital flows (e.g. share transactions and the buying and selling of Government debt) and direct capital flows arising from foreign investment.
The exchange rate and the balance of payments
Changes in the exchange rate can have a big effect on the balance of payments although these effects are subject to uncertain time lags. When sterling is strong then UK exporters found it harder to sell their products overseas and it is cheaper for UK consumers to buy imported goods and services because the pound buys more foreign currency than it did before.
The Balance of Payments and the Standard of Living
A common misconception is