1. The Balance of Payments • What is the Balance of Payments? • The structure of the balance of payments • What are the BOP accounts? • The BOP Recording Method: Double-Entry Bookkeeping Method • Balance of Payments Balances • The Balance of Payments and the FX Market

2. Balance of Payments • The balance of payments is an accounting listing (tabulation) of the values of economic (trade and financial) transactions between the residents of a (home) country and residents of other countries. • Balance of payments entries are recorded based on the double-entry bookkeeping principle. • The balance of payments entries are always balanced; the entries add up to zero.

3. Balance of Payments Account Categories • Current Accounts • Merchandise Trade • Service Trade • Services of Capital: Interest Incomes, Dividends • Unilateral Current Transfers • Capital Accounts • US private investments abroad • Foreign private investments in the US • Other investments/capital transactions • Errors and statistical discrepancies • Official (Capital) Accounts • (Changes in) US official reserve assets abroad: gold, SDRs, foreign currencies • (Changes in) foreign official assets in the US

4. Double-Entry Principle • Each transaction affects at least two account • Debit entries balance credit entries • Imports are debit entries ( Autonomous transactions) • The balancing (credit) entry(ies) for an import take(s) place in one (or more) sections of capital the accounts (Accommodating transactions) • Exports are credit entries ( Autonomous transactions) • The balancing (debit) entry(ies) for an export take(s) place in one (or more) sections of the capital accounts (Accommodating transactions) • Capital inflows (increases in foreign assents) are credit entries • Capital outflows (increases in US residents-owned assets abroad) are debit entries • Increases in US claims against residents of other countries are debit entries • Increases in foreign residents’ claims against US are credit entries

5. Balance of Payments Balances • Balance of Merchandise Trade • Balance Merchandise and Services • Current Account Balance • Capital Account Balances • Official Settlement Balance • Statistical errors • Overall Balance = 0

6. How does the BOP balance? Debit(-)Credit (+) Exports 100(+) Imports 120(-) Current Account Balance -20 Reduction in US bank Deposit claims abroad 10 Official Settlement Balance -10 Reduction in official reserves 10 Balance of Payments 00

7. The Current Account Entries • Merchandise Trade • Exports (+) • Imports (-) • Service Trade • Exports (+) • Imports(-) • Investment Incomes • Incomes received (+) • Incomes paid (-) • Unilateral Transfers

8. Capital Accounts Entries • Unofficial Capital Transactions • Purchase (or sale) of foreign assets (Direct and indirect) • Purchase (or sale) of home assets by foreign residents (Direct and indirect) • US Official Accounts • US Assets • Gold reserves • FX reserves (deposits) • SDRs • Foreign Official Assets in the US (US liabilities) • US government securities held by foreign officials • US Treasury bills held by foreign officials • Other foreign official assets in the US • Other liabilities to foreign official

9. BOP Deficits and Surpluses • Current Balance + Capital Balance+ Official Settlement Balance + Statistical discrepancies = 0 • Balance of Merchandise Trade • Balance of Merchandise and Service Trade • Current Balance • Capital Balances • Current Balance + Capital Balance + Statistical discrepancies = BOP • BOP = Official Settlement Balance

10. BOP &Foreign Exchange Markets • Given that each nation state has its own currency (with which domestic transactions are carried out), all international transactions potentially generate either supply of or demand for foreign exchange. • Generally, transactions resulting in debit entries in the BOP generate demand for FX(e.g., imports, investments abroad); transaction resulting in credit entries generate demand(e.g., exports, foreign investments in the US) • Foreign exchange markets are places, systems, or mechanisms through which currencies are exchanged or traded. • Overall (multilateral) BOP accounts and bilateral BOP accounts

11. A balanced set of transactions • A balanced set of transactions does affect the official settlement balance: • An import finance by the seller • A foreign investment investment financed by an American bank holding FX deposits in a foreign bank

12. Foreign Exchange Markets S $ e1 eo e2 (i$, iY, ee,ef) D Yen o

13. Foreign Exchange Markets: A Flexible Rate System S $ e1 At parity : (i$ - iY)=p (i$ - iY) = ( ee-e)/e eo e2 (i$, iY, ee,ef) D Yen o