Unit 7- Balance Payments

Balance of Payments
The measure of money inflows and outflows between the US and the rest of the world (ROW)

• Inflows are referred to as credits
• Outflows are referred to as debits

The Balance of Payments is divided into 3 accounts.

• Current Account
• Capital/Financial Account
• Official Reserves Account

Current Account
Balance of Trade or Net Exports

• Exports of Goods and Services (G&S)
• Exports create a credit to the balance of payments
• Imports create a debit to the balance of payments
• Net Foreign Income
• Income earned by US owned foreign assets - Income paid to foreign held US assets.
• Example: Interest payments on US owned Brazilian bonds - Interest payments on German owned US treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign aid ➝ a debit to the current account
• Example: Mexican migrant workers send money to family in Mexico.

Capital/Financial Account

The balance of capital ownership.

• Includes the purchases of both real and financial assets
• Direct investment in the US is a credit to the capital account.
• Ex. Toyota factory in San Antonio
• Direct investment by US firms/individuals in a foreign country are debits to the capital account.
• Ex. The Intel factory in San Jose, Costa Rica

• Purchase of foreign financial assets represents a debit to the capital account
• Ex. Warren Buffet buys stocks in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.
• Ex. The United Arab Emirates Sovereign Wealth Fund purchases a large stake in the NASDAQ
• Relationship between Current and Capital Account
• The current account and the capital account should zero each other out.
• That is...if the current account has a negative balance (deficit), then the capital account should then have a positive balance (surplus)

Official Reserves

The foreign currency holdings of the US Federal Reserve System

• When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments.
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.
• The official reserves zero out the balance of payments.

Formulas

• Balance of trades
• Good exports + good imports
• Balance of Goods and Services
• (Goods exports + service exports) + (Goods imports + services imports)
• Current Account
• Balance of Goods and Services + Net investment income + Net transfers
• Capital Account
• Foreign purchases of assets + US purchase of assets
• Official Reserves
• Current Account + Capital Account

Unit 4- Monetary Policy

Monetary Policy

• Open Market Operations (OMO): When the Fed buys or sells bonds
• Discount Rate (DR): where FDIC member banks and other eligible institutions may borrow short term loans directly from the Federal Reserve.
• Federal Funds Rate (FFR): Where FDIC member banks loan each other overnight funds.
• Prime Rate: Interest rate that banks charge to their most credit worthy customers.

Monetary is always conducted by the Fed, and only affects AD through investment spending.

In an recession, Fed uses expansionary monetary policy

• Actions taken by Fed:
• Open Market Operations: Buy bonds; MS increases
• Discount Rate: Lowered
• Reserve Requirement: Lowered
• Federal Funds Rate: Lowered

In an inflation, Fed uses contractionary monetary policy

• Actions taken by Fed:
• Open Market Operations: Sells bonds; MS decreases
• Discount Rate: Raised
• Reserve Requirement: Raised
• Federal Funds Rate: Raised

Unit 4- Loanable Funds Market

Loanable Funds Market

• The market where savers and borrowers exchange funds (QLF) at the real rate of interest (r%)
• The demand for loanable funds or borrowing comes from households, firms, government, and the foreign sector. The demand for loanable funds is in fact the supply of bonds.
• The supply of loanable funds, or savings comes from households, firms, government and the foreign sector. The supply for loanable funds is also the demand for bonds.

Changes in the Demand for Loanable Funds(DLF)

• Remember that demand for loanable funds = borrowing (ex. supplying bonds)
• More borrowing = More demand for loanable funds (➝)
• Less borrowing = Less demand for loanable funds (←)

Examples

• Government deficit spending = more borrowing = more demand for loanable funds
• DLF shifts to the right
• Real rate of interest (r%) goes up

• Less investment demand = less borrowing = less demand for loanable funds
• DLF shifts to the left
• Real rate of interest (r%) goes down

Changes in the Supply for Loanable Funds(SLF)

• Remember that supply of loanable funds = saving(ex. demand for bonds)
• More saving = More supply of loanable funds (➝)
• Less saving = Less supply of loanable funds (←)

Examples

• Government budget surplus = more saving = more supply of loanable funds
• SLF shifts to the right
• r% goes down
• Decrease in consumers' MPS = less saving = less supply of loananble funds
• SLF shifts to the left
• r% goes up

Unit 4- Money Market

The Money Market

• The market where the Fed and the uses of money interact thus determining the nominal interest rate (i%)
• Money Demand (MD) comes from households, firms, government and the foreign sector.
• The Money Supply (MS) is determined by the Federal Reserve 

Money Demand

• Transaction Demand: demand for money as a medium of exchange (independent of the interest rate)
• Asset Demand: demand for money as a store of value (dependent on the interest rate)
• Total Money Demand: MD is downward sloping because at high interest rates people are less inclined to hold money and more inclined to hold stocks and bonds. At lower interest rates people sacrifice less when they hold money.

• Money supply is determined by the Federal Reserve because the Federal Reserve has monopoly control over the supply of money.

Unit 4- Money

Functions of Money

1. Medium of Exchange
• Serves to trade one product to another
2. Store of Value
• Where money holds it's value over a period
3. Unit of Account
• Establishes economic worth

Types of Money

1. Commodity Money
• It gets its value from the type of material from which it's made
• Example: Gold, silver
2. Representative Money
• Paper money backed by something tangible that gives its value.
• Example: Gold-or-silver-backed money and IOUs
3. Fiat Money
• Money because the government says so

Characteristics of Money

1. Durability
2. Portability
3. Divisibility
4. Uniformity
5. Scarcity
6. Acceptability
7. Limited supply

Money Supply

1. M1 Money

• Consists of currency in circulation, which can be:
• Currency (cash and coins)
• Checkable deposits aka demand deposits and checking accounts
• Traveler's checks

Liquidity: easy to convert to cash

      2. M2 Money

• Consists of M1 money + savings accounts + money market accounts
• Savings accounts: a bank account where you can store money you don't need right away but still keep it easily accessible
• Money market accounts: savings account with some checking features; they typically come with checks or a debit card and allow a limited number of transactions each month; traditionally, they've also offered higher interest rates than regular savings accounts

      3. M3 Money

• Consists of M2 money + Certificates of deposit

Time Value of Money

• v = future value of $
• p = present value of $
• r = real interest rate (nominal rate - inflation rate) expressed as a decimal
• n = years
• k = number of times interest is credited per year

The Simple Interest Formula: v = (1+r)^n * p
xπxπ * p

The Compound Interest Formula: v = (1+r/k)^nk * p

Balance/Business Sheet

-Summarizes the financial position of a bank at a certain time

-The value of assets must equal the value of claims
-Claims on a balance sheet are divided into two groups

Assets (Credit)

• Required Reserves (RR)
• Excess Reserves (ER)
• Loans
• Property
• Bonds (Government securities)

Liabilities (Debt)

• Demand Deposits
• Owner's Equity
• Net worth

Owner's Equity: Based on how much you invested into stock

Net Worth: What you've earned

The Federal Reserve

Fractional Reserve Banking System

• The banks have to hold a fraction of the total money supply as currency

Money Creation

Putting new money into circulation using two methods

1. When the federal reserve bank buys bonds from people or financial institutions (OMO or open market operations)
2. When banks make loans to the public

• The money supply is increased when banks make loans.
• The more loans banks make, the more money there is in circulation.
• A bank can loan any amount that is in excess of its required reserves.
• The banking system can create loans in multiples of an original loan

• Reserves or total reserves
• The amount of deposits that a bank has accepted but not loaned out.
• Required Reserves
• The amount a bank must keep on hand by law
• Excess Reserves
• Whatever the bank has over and above the required reserves
• The required reserve ratio determines this amount

Functions of the FED

• It issues paper currency
• Sets RR and holds reserves of banks
• It lends money to banks and charges them interest
• They are a check clearing service for banks
• It acts as personal bank for the government
• Supervises member banks
• Controls the money supply in the economy

Types of Multiple Deposit Expansion Question

• Type 1: Calculate the initial change in ER
• aka. the amount a single bank can loan from the initial deposit
• Type 2: Calculate the change in loans in the banking system
• Type 3: Calculate the change in the money supply
• Sometimes type 2 and type 3 will have the same result (i.e. no Fed involvement)
• Type 4: Calculate the change in DD