Balance of Payments

Balance of Payments: measure of money inflows and outflows between the U.S 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/services - imports of goods/services
-Exports create a credit to the balance of payment
Imports create a debit to the balance of payment

Net Foreign Income
(Income earned by U.S. owned foreign assets) - (Income paid to foreign U.S. assets)

Ex: Interest payments on U.S. owned Brazillian bonds - Interest payment on German-owned U.S. treasury bonds

Net Transfers (tend to be unilateral)

Relationship between Current and Capital Account
cancel each other out
if current account has a negative balance (deficit) then capital account has a positive balance (surplus)

Official Reserves
- 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 reserve of foreign currency and credits the balance of payments
- The Official Reserves cancel out the balance of payment Balance of Trade=Goods exports + Good imports

Formulas:

Balance of Goods and Services=(Goods exports + Service exports) + (Goods imports + Service imports)
Current Account=(Balance of Goods and Services) + (Net Investment Income) + (Net Transfer)
Capital Account=(Foreign purchases) + (US (or another country) purchases)
Official Reserves=Current Account + Capital Account

Monetary Policy

Monetary Policy:

Open Market Operations (OMO): When the Fed buys or sells bonds.

Discount Rate: FDIC member banks and other eligible institution may borrow short term loans from the Fed (bank borrow from the Fed)

Federal Funds Rate: FDIC member banks loan each other overnight funds. (banks borrow from other banks)

Reserve Requirement: The required amount a bank must keep on hand by law

Recession:

Open Market Operations:

The Fed buys bonds

reserve: ↑

Discount Rate:  ↓

Reserve Requirement:  ↓

Federal Funds Rate: ↓

Money Supply:  ↑

Inflationary Policy:
Open Market Operations: The Fed sells bonds

reserve:  ↓

Discount Rate:  ↑

Reserve Requirement:  ↑

Federal Fund Rate ↑

Money Supply: ↓

The Loanable Funds Market

The Loanable Funds Market
-The market where savers and borrowers exchange funds (QLF) at the real rate of interest (r%).

-The demand for LF, or borrowing, comes from households, firms, the government, or the foreign sector. The demand for LF is, in fact, the supply of bonds.

-The supply of LF, or savings, comes from households, firms, the government, or the foreign sector. The supply of LF is, in fact, the demand for bonds.

Changes in Demand for Loanable Funds

-demand for loanable funds= borrowing (ie, supplying bonds)

-More borrowing = more demand for loanable funds (LF→)

-Less borrowing = less demand for loanable funds (LF ←)

Ex:

-Government deficit spending : = more borrowing
= more demand for LF
- DLF → and r% ↑

-Less investment demand : = less borrowing
= less demand for LF
-DLF ← and r% ↓

Changes in Supply of Loanable Funds

-remember that supply of loanable funds= saving (ig. demand for bonds)
-More saving = more supply of loanable funds

-Less saving = less supply of loanable funds

Ex:
-Government budget surplus : = more saving
= more supply of LF
SLF → and r% ↓

-Decrease in consumers' MPS: = less saving
= less supply of LF
SLF ← and r% ↑

Money market

The Money Market :

The money market is where the Federal Reserve and the users of money interact, thus determining the nominal interest rate (i%).

It is composed of two parts:

- Money demand (MD) comes from households,
firms, government, and the foreign sector.

- Money supply (MS) is determined only
by the Federal Reserve.


Parts of Money Demand :

Transaction demand :is the demand for money as a medium of exchange (independent of interest rate).

Asset demand : is the demand for money as a store of value (dependent of 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

3 Uses of Money:
-Medium of Exchange: Serves to trade one product for another
-Unit of Account: Establishes economic worth
-Store of Value: Money holds its value over a period
of time whereas products may not.

3 Types of Money:
1. Representative Money: Paper money that is backed by something tangible that gives it value.
Ex. IOU

2. Commodity Money: Gets its value from the type of material from which it is made.
Ex. Gold or Silver

3. Fiat Money: It is money because the government says so.
Ex. Paper money

7 Characteristics of Money:
-Durability
-Portability
-Divisibility
-Acceptability
-Uniformity
-Scarcity
-Limited Supply

Money Supply
M1 Money
Currency
Checkable Deposits
Traveler's Checks
Liquidity (Easy to convert to cash)

M2 Money :
Consists of M1 Money
Savings Accounts
Money Market Accounts

M3 Money: 
Consists of M3 Money
Certificate of Deposit (CD)

Balance Sheet: Summarizes the financial position of the bank at a certain time.
Value of assets must equal liabilities at all times!

Assets:
1. Required reserves (RR)

2. Excess Reserves (ER)

3. Bonds

4. Loans

5. Property

Liabilities:
1. Demand Deposits

2. Owners Equity (stock)

3. Net Worth (money earned)

Money Creation:
Putting money into circulation (2 ways)

1. When the FED buys bonds from the public or from a financial institution. (Open Market Operation).

2. When the banks make loans to the public

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 of total reserves are 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
Required Reserve Ratio determines this amount

Functions of the FED:

Issues paper currency

Sets reserve requirements and holds reserves of banks

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 economy.

Types of Multiple Deposit Expansion Questions
Type 1: calculate the initial change in excess reserves (amount a single bank can loan)
Type 2: calculate the change in loans in the banking system
Type 3: calculate the change in the money supply

Type 4: calculate the change in demand deposits 

Fiscal Policy

Fiscal Policy = Changes in the expendetures or tax revenues of the federal government

2 tools of fiscal policy:

- taxes: government can increase or decrease taxes

-spending: government can increase or decrease spending.

-Fiscal Policy is enacted to promote our nations economic goals: Full employment, price stability, economic growth.

Deficits,Surpluses, and Debt

Balanced Budget
-Revenues = expenditures

Budget Deficit
-Revenues< Expenditures

Budget Surplus
-Revenues>Expenditures

FORMULA : Government Debt= Sum of all deficits - Sum of all surpluses

Government borrows from
-Individuals
-Corporations
-Financial Institutions
-Foreign entities or foreign governments

Fiscal Policy, two options

Discretionary fiscal Policy
-Expansionary Fiscal Policy- think deficit
-Constructionary fiscal policy- think surplus

Non-Discretionary fiscal Policy (no action)

Discretionary v Automatic Fiscal Policies

Discretionary : increasing or decreasing government spending and'or taxes in otder to return the conomy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economy problem

Automatic: unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place having to respond to current economic problems.



Expansion fiscal policy:
Increase government spending (G^)
Decrease taxes (T⌄)
Notice that the PL increase. This means expansionary fiscal policy creates some inflation

Contractionary fiscal policy

Decrease government spending (G)
Increase taxes (T^)

Weaknesses of fiscal policy:

Lags
-inside lag: takes time to recognize economic problems and to promote solutions to the problems.
-outside lag: it takes time to implement solution to problem

Supply side policies

Stimulate production supply to spur output

Cut taxes and government regulations to incentives for businesses and individuals.

Businesses invest Ana expands creating jobs people work save and spend more.

Increasing investment and productivity leads to increased output

Demand side policies

Stimulate consumption of goods and services (demand to spur output)

Cut taxes or increase federal spending to put money into people’s hands

With more money People buy more

Businesses increase output to meet growing demand

Automatic or built in stabilizers:

Anything that increases the government budget deficit during a recession and increased its budget surplus without requiring explicit access by policy makers.

Transfer payments:
-welfare checks
-food stamps
-payment checks
-corporate dividends
-social security
-veterans benefits

Tax system 

Progressive tax system
-average tax rate (tax revenue/GDP) rises with GDP

proportional tax system
-average tax rate remains constant as GDP changes

Progressive  tax system
-average tax rates falls within GDP

Consumption and Saving

Disposable Income(DI)
  -income after taxes or net income
2 choices:
-with disposable income households can either
  -consume(spend on goods and services)
  -save(not spend on goods and services.)
Consumption
-Household spending
-Ability to consume is constrained by
  -the amount of disposable income
  -the propensity to save
Do Households consume if DI=0
  -Autonomous consumption

Saving
-Household NOT Spending
-The ability to save is constrained by
  -The amount of disposable income
  -The propensity to consume
Do households save if DI=0?
 no

APC & APS
APC + APS = 1
1 - APC= APS
1 - APS = APC
APC > DISSAVING
-APS DISSAVING

MPC & MPS
marginal propensity to consume
  -△C/△DI
  -% of every extra dollar earned that is spent

marginal propensity to save
 - △S/△DI
 - % of every extra dollar earned that is saved

MPC+MPS=1
1-MPC=MPS
1-MPS=MPC

Marginal propensity to consume

MPC= △ in consumption
           ------------------------
           △ In disposable income

MPS= △ in savings
           -----------------------
           △ in disposable income

The spending multiplier effect
- an initial change in spending (C.IG, G , Xn) causes a larger change in aggregate spending or aggregate demand (AD)

Multiplier= △in AD/ △in spending

Multiplier= △S/△C,Ig,G,Xn

Why does this happen?
-expenditures and income flow continuously which sets off a spending increase in the economy.

Calculating Spending multiplier
-can be calculated from MPC or MPS

Multiplier= 1/1 - MPC  OR  1/MPS

-multipliers are + when theres an increase in spending and - when there is a decrease.

How to calculate tax multiplier
-when government taxes, the multiplier works in reverse.
Why?
- because money is leaving circular flow.
Tax Multiplier (note: its negative)
= -MPC/1 - MPC or -MPC/MPS
If there is a tax CUT then multiplier is + because there's more money in circular flow.