Unit 5: Balance of Payments

Balance of Payments

• Measure of money inflows and outflows between the United States and the Rest of the World (ROW)
• Inflows are referred to as CREDITS
• Outflows are referred to as DEBITS

The Balance of Payments are divided into three accounts 

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

Current Account 

• Balance of Trade or Net Exports
• Exports of Good/Services - Import of Goods/Services
• Exports create a credit to the balance of payments
• imports create a debit to the balance of payments

Net Foreign Income

• Income earned by the U.S. owned foreign assets - income paid to foreign held U.S. assets.
• Ex: Interest payments on U.S. owned Brazilian bonds - interest payments on German owned U.S. Treasury bonds

Net Transfers

• Foreign Aid --> a debit to the current account
• Ex: Mexican immigrant workers send money to family in Mexico.

Capital/Financial Account

• the balance of capital ownership
• includes the purchase of both real and financial assets.
• Direct investment in the U.S. is a credit to the capital account. Ex: The Toyota Factory in San Antonio .
• Direct investments by U.S. 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 stock 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

• Should ZERO each other out. 

If the current account has a negative balance (deficit), then the capital account should have a positive balance (surplus).

Official Reserves

• The foreign currency holdings of the U.S. 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.
• Official Reserves ZERO out the balance of payments.

Active v. Passive Official Reserves 

• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

Balance of Trade:

• Goods Exports + Good Imports

Balance on Goods and Services:

• Goods Exports + Service Exports + Goods Imports + Service Imports

Current Account 

• Balance on goods and services + Net Investment + Net Transfers

Capital Account 

• Foreign Purchases + Domestic Purchases

Unit 5: Short Run Phillips Curve and Long Run Phillips Curve

SRPC

• There is an inverse relationship between unemployment and inflation.

LRPC 

• it occurs at the long rate of unemployment
• it is always represented by a vertical line
• there is no trade off between unemployment and inflation
• it will only shift if LRAS shifts
• if the NRU shifts or changes so does the LRPC
• (Natural Rate of Unemployment) Un = Frictional + Seasonal Unemployment (4-5%)
• The major LRPC assumption is that more worker benefits create higher natural rates and a few worker benefits create lower natural rates.

Misery Index 

• Where you have a combination of inflation and unemployment in any given year.
• Single digit misery is good.

Supply Shocks 

• Rapid & significant increase in resource cost, due to many things.

Disinflation

• Long Run Phillips Curve

Deflation

• General decline in prices

Supply side economists 

•  support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneur ventures. 

Incentives to save and invest

1. High marginal tax rates reduce the rewards for savements and investment.
2. Consumption might increase but investments depend on savings.
3. Lower marginal tax rates encourage saving and investment.

Laffer Curve 

•  It is a theoretical relationship between tax rates and tax revenues. As tax rates increase from zero to some maximum level and then decline. 

3 criticisms of the Laffer Curve

1. Evidence suggests that the impact of tax rates in incentives to work, save and invest are small.
2. Tax cuts also increase demand which can fuel inflation, and demand may exceed supply.
3. Where the economy is actually located on the curve is difficult to determine.

Unit 5: Phillips Curve

Original SR Phillips Curve

• Inflation and unemployment are inverse of each other
• Inflation increases as the economy expands
• Recession- unemployment increases as the economy slows down 

Stagflation

• Is an increase in inflation and unemployment at the same time.

A New Phillips Approach 

• New Range - The SRPC can move outward and inward
• Cost Push Inflation is when there is more stress on resources, wages and input cost.
• Supply Shocks -  A rapid loss of resources or rapid increase in resource cost.
• The SRPC Curve moves outward during these shocks
• The SRPC moves back inward as the society increases productivity and/or regains resources.

Long Run Phillips Curve

• Inflation- Society will adjust for a cost/wage increases with new prices.
• LRPC is the efficient PPF
• Natural Rate of Unemployment becomes the equivalent of the full employment rate

Phillips and AD/AS Curves

• Change points on SRPC - Along the curve
• Move the SRPC - Shift the curve on the SRPC

Unit 5: Long Run Phillips Curve

• Because the Long-Run Phillips curve exists at the natural rate of unemployment( Un) structural changes in the economy that affect unemployment will also cause the LRPC to shift.
• Increase in the Natural Rate of Unemployment will shift LRPC to shift to the right
• Decrease in the Natural Rate of Unemployment will shift LRPC to shift to the left.
• X axis: Inflation rate
• Y axis Unemployment rate

Unit 5: Short Run and Long Run AS

Short Run Aggregate Supply 

• In macroeconomics this is the period in which wages (and other input prices) remain fixed as price level increases or decreases.

Effects over Short-Run

• In the short-run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant.
• In the long run, wages will adjust to the price level and previous output levels will adjust accordingly.

Equilibrium in the Extended Model

• The extended model means the inclusion of both the short and long run AS curves.

Demand Pull Inflation in the AS 

• Prices increase based on increase in aggregate demand
• In the short run, demand pull will drive up prices and increase production.
• In the long run increase in aggregate demand will eventually return to previous levels.

Cost Push

• Arises from factors that will increase per unit costs such as increase in the price of a key resource.

Dilemma for the government 

• In an effort to fight cost push, the government can react in two different ways.
• Action such as spending by the government could begin an inflationary spiral.
• No action however could lead to recession by keeping production and unemployment levels declining.



Unit 4: Withdrawals and the Banking System

• When a customer deposits cash or withdraws cash from their demand deposit, it has NO EFFECT on Money Supply.

It only changes

• The composition of money
• Excess reserves
• Required reserves 

Single bank (Ex: Chase) 
Can only loan money from excess reserves 

Banking system (Ex: Chase, Wells Fargo)  

Formulas:

ER x Multiplier =  Total Money Supply

•  When the FED buys or sells bonds, ER is created. Take the number that was bought or sold and multiply it by the multiplier