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