AP Macro: Unit 7 “The Open Economy: International Trade and Finance”

Balance of Payments In a closed economy, economists keep track of transactions with the national income account (GDP). In an open economy, (with international trade) they keep track with the “balance of payments accounts.”

Balance of Payments Definition: a summary of a country’s transactions with other countries

Example: The Ryan family farm $100,000 revenue from selling rhubarb Spent $110,000 on purchase of machinery, buying food, paying bills, etc. Received $500 in interest on bank account, but paid $10,000 interest on mortgage Took out a $25,000 loan for farm improvements

The Ryan Financial Year Cash: spent $110,000; made $100,000 Net -$10,000 Interest: spent $10,000; made $500 Net -$9,500 Loans/Deposits: borrowed $25,000; deposited $5,500 after covering losses Net $19,500 Balance $0

Sources of cashUses of cashNet Purchases/sales of G&S Rhubarb sales: $100,000Expenses: $110,000($10,000) Interest Payments Bank acct revenue: $500Mortgage: $10,000($9,500) Loans/depositsNew loan: $25.000Bank deposit: $5,500$19,500 Total$125, 500 $0 The Ryan’s Financial Year

Balance of Payments When a U.S. resident sells a good, such as wheat, to a foreigner, that’s the end of the transaction. But a financial asset, such as a bond, is different. That sale creates a liability in the future. The balance of payments accounts distinguish between transactions that create liabilities and those that don’t.

Current Account Transactions that don’t create liabilities are part of the current account This is primarily the balance of payments on goods and services The difference between the value of exports and the value of imports (in Unit 2 we called this “net exports”)

Financial Account Transactions that involve the sale or purchase of assets, and therefore create future liabilities, are part of the financial account (we used to call this the capital account)

Current / Financial Account General Rule: Current Account + Financial Account = 0 The sources of cash must equal the uses of cash Remember the circular flow: one person’s (or country’s) expenses are another person’s (or country’s) income

United States Rest of World Payments to the rest of the world for assets Payments to the United States for assets Payments to the rest of the world for G&S (negative component of U.S. current acct) Payments to the United States for G&S (positive component of U.S. current acct)

Payments from foreigners Pmts to foreignersNet Sales/ purchases of G&S$1,827$2,523($696) Factor income$765$646$119 Transfers ($128) Current Account Balance ($705) Gov't Asset sales/purchases$487$530($43) Private asset sales/purchases$47($534)$581 Financial Account Balance $538 Total ($167) Note: -$167 is just a statistical error. Not bad when managing $3.5T! The U.S. Balance of Payments in 2008 (billions of dollars)

Review Q : The current account plus the financial account is equal to: a.Zero b.One c.The trade balance d.The size of the trade deficit e.Sorry, I’ve been napping.

Financial Account Measures capital inflows from foreign savings that become available for domestic investment Which brings us back to our good friend: the market for loanable funds Let’s look at the loanable funds market in two economies: Shieldsville and Mocabeetown