Trade Balance, Current Account and Capital Flows:

Balance of Payments Accounts Current Account Transactions:

1. Merchandise Balance = Exports - Imports of Goods 2. Net Exports (Trade Balance, NX) = Merchandise

Balance plus Net Exports of Services (or Balance on Goods and Services)

3. Current Account Balance (CA) = Trade Balance + Net Factor Income from Abroad ( = NX + i NFA)

The economy's financial position vis a vis the rest of the world

• If NFA is the net stock of foreign assets held by people in the United States (US ownership of foreign assets, net of foreign ownership of US assets), then (excepting changes in asset valuation) changes in NFA are equal to the current account:

• NFAt+1 = NFAt + CAt . • In fact, the net foreign assets at the beginning of next

period (t+1) must be equal to those in period t plus total national income (GNP) minus the part of national income that is consumed (C and G) or invested (I):

• NFAt+1= NFAt + GDPt + it x NFAt - Ct - Gt - It = NFAt + CAt

The relation between the current account and the net foreign assets

of the country: Another Look

another way of seeing the relation between the current account and the net foreign assets of the country is to see the link between the current account of the BP (that records current transactions, i.e. trade in goods and services and the interest payments on net foreign assets) and the capital account of the BP (that records capital transactions, i.e. the purchase and sale of foreign assets). In particular, we will show that the sum of the current account (CA) and capital account (KA) of the balance of payments is equal to the change in the official foreign reserves of the country (d(FAX) or:

CA + KA = d(FAX)   Intuitively, the above expression makes sense. Suppose, for a

moment, that the change in official foreign reserves is zero (d(FAX)=0) so that the overall balance of payments (the sum of the current and capital account is zero):

CA+KA=0

FAX= Official foreign reserves

balance of payments identity• To derive more formally  the above balance of payments identity (1)

note that: • NFA = Foreign Assets (FA) - Foreign Liabilities (FL) = • = Domestic Assets Abroad - Foreign Assets in the Domestic Country = • = Foreign Assets held by Domestic Residents - Foreign Debt owed by

Domestic Residents • Let us first distinguish between assets and liabilities of the private

sector and the government sector: • FA = FAP + FAX • FL = FLP + FLG • where FAP are the foreign assets of the private sector and FAX are the

foreign assets of the government sector (the official foreign reserves of the country that are usually held by the central bank, a government agency). Similarly, the total foreign debt of the country FL is the sum of the foreign debt of the private sector (FLP) and the foreign debt of the government (FLG).