þBOP accounting is the recording of transactions between domestic and foreign economic agents. þAny transaction that results in a receipt of money by domestic agents from abroad is recorded as a credit in the BOP accounts. þAny transaction that entails the payment of money by domestic units to foreigners is recorded as a debit in the BOP accounts. þThe current account records foreign transactions involving merchandise and services. þThe capital account records foreign transactions involving financial assets and land.

Source: The Economist Current Account balance of selected industrialized nations, August 1998 to August 1999

An exchange rate is the price of one national currency expressed in terms of another national currency. For example, the dollar price of the British pound is $ meaning it takes $1.71 to buy 1 pound

Exchange rates are determined by the supply and demand of foreign exchange DM per $ $’s0 S D D’ Why do agents want to swap marks for dollars? To buy American-made goods. To hold stocks in U.S. companies or other dollar- denominated assets. To speculate on future exchange rate movements In this case, the mark depreciates against the dollar

Currency Cross Rates New York Trading,July 9, 1999 Source: Wall Street Journal

Firms and individuals demand marks to buy German- made goods, to hold mark-denominated financial assets, or to profit from what they hope will be an increase in the international value of the mark. $ per DM DMs D S S’  Dollar appreciates against the mark

Let the dollar price of the mark = $0.59--i.e., it costs 59 cents to purchase 1 mark in the market for foreign exchange. Let the mark price of a Krups espresso maker = 100 marks Question: What is the dollar price of the Krups espresso maker? $ price = (.59)(100) = $59.00

Effect of an appreciating dollar on the price of imported goods What if the dollar should appreciate, or gain value, against the mark? Let the dollar price of the mark decrease to $0.55. Question:What is the dollar price of the Krups espresso maker? $ price = (.55)(100) = $55.00

Let the mark price of the dollar = 1.69 marks--i.e., its cost 1.69 marks to buy a dollar in the foreign exchange market. Let the dollar price of the Microsoft Windows 98 = $ Question:What is the mark price of Windows 98? Mark price = (1.69)(189.00) = marks

Effect of a depreciating mark on the price of Windows 98 Let the mark price of the dollar increase to 1.82 marks. Question:What is the mark price of Windows 98? Mark price = (1.82)(189.00) = marks

Like a federal deficit, a trade deficit must be financed. If international borrowing is ruled out,then a a deficit might “crowd out” private borrowing and investment The following holds for an open economy without external (foreign) borrowing: S p = I + Government Deficit + Trade Deficit

 Allowing for external (foreign) borrowing, the following is true by definition: S P + foreign borrowing  I + government deficit + trade deficit External borrowing can impact domestic interest rates, and leave the nation vulnerable to “capital flight.”It can also comprise political autonomy