Outline 2: The Balance of Trade, Balance of
Payments (BOP) and International
Macroeconomics
2.1 Introduction to the Balance of Trade and
Payments
2.2 International Macroeconomics
2.3 Conclusions on BOP
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2.1 Introduction to the Balance of Trade and
Payments
• BOP:
– Summary financial statement of a nation’s
transactions with the world
– 3 Accounts:
• Current Account (X-M)
• Capital Account (ΔK)
• Official Reserves Account (ORA)
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2.1 Introduction to the Balance of
Trade and Payments
• BOP: Notation
X = domestic currency value of exports,
M = domestic currency value of imports
Δ K = domestic currency value of net capital
outflows (capital investment to other countries)
ORA = official reserves account settlement (assume
this is 0 for US BOP analysis; its very small as
non-US trading partners want to hold $’s
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2.1 Introduction to the Balance of
Trade and Payments
• BOP: Double-Entry Bookeeping
(X-M) + Δ K+ ORA = 0 BOP Accounting Identity:
Current account plus capital account sum to 0 as
US ORA assumed equal to 0.
(X-M) > 0 current account trade surplus
(X-M) < 0 current account trade deficit
(X-M) = - Δ K Deficit in current account is offset by
net capital inflows; foreigners buy assets with US
$.
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2.1 Introduction to the Balance of
Trade and Payments
• Current Account: reflects net flow of goods
and services (exports and imports), income,
and unilateral transfers
• Capital Account:
– reflects public and private lending and investment
activities
– Portfolio (maturities >1 year), direct investment
(equity >10%), short-term investment (< 1 year)
criteria
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2.2 International Macroeconomics
• Relationship Between Macro-Economy and BOP:
Notation:
Y = GDP or $ value of national output or aggregate supply
C = national level of consumption expenditures
S = national level of savings
I = national level of investment
Yd = national level of expenditures or aggregate demand
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2.2 International Macroeconomics
Relationship Between Macro-Economy and BOP:
Y=C+S
consume or save output
Yd = C + I
expenditures are consume or invest
Y – Yd = S - I capital surplus invested abroad
S > I leads to –ΔK or capital outflow
S < I leads to + Δ K or capital inflow
Y – Yd = X – M excess of output sold to foreigners
S – I = X – M net foreign investment = trade surplus
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2.2 International Macroeconomics
Relationship Between Macro-Economy and BOP:
X > M leads to S > I Trade surplus leads to positive net foreign
investment or capital outflows
X < M leads to S < I Trade deficit leads to negative net foreign
investment or capital inflows
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2.2 International Macroeconomics
Relationship Between Macro-Economy, BOP, and Government Deficits:
Government budget deficit occurs when government spending for a year is greater
than tax receipts.
Yd = (C-T) + I + G where: T=tax receipts, G=gov’t spending,
and (C - T) is private consumption
Y - Yd = (S - I) - (G - T)
X – M = (S – I) - (G - T) Government deficits worsen current account balance and
have foreign capital inflows to finance gov’t deficit.
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2.2 International Macroeconomics
• What does this all mean?
– Nation that produces more than it spends saves more than it
invests, exports more than imports, and has a capital
outflow.
– Nation that produces less than it spends saves less than it
invests, imports more than exports, and has a capital
inflow.
– Nation with a gov’t deficit will exacerbate trade deficits
and capital inflows.
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2.3 Conclusions on BOP
• What does this mean for FX rates?
– A trade deficit (home goods too expensive)
• Appreciation of domestic currency and a fall in FX rate
(e)
– A trade surplus (home goods cheap
• Depreciation of domestic currency and a rise in FX rate
(e)
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2.3 Conclusions on BOP
• US has consistent trade deficits.
• US has consistent gov’t. budget deficits:
– National debt = Sum{all past budget deficits}
– National debt is about $17b
www.treasurydirect.gov
– 26% (46% of 57% of debt held by public) of US
gov’t. bonds held by foreigners (mainly Saudi
Arabia, China & Japan)
• US long-term savings rate (< 5%) is low
(relative to Japan at > 20%).
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2.3 Conclusions on BOP
• The US trade deficit has been driven by a
strong dollar due to high demand for safe US
stocks and bonds:
– Foreigners bought US assets thereby bidding up
value of $
– US bought foreign goods/services with FX from
sale of $ helping to drive trade deficit.
– Capital account is driving the current account in
US.
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