APMacro: International Trade and Finance Review

  • U.S. exports create a foreign demand for dollars and make a supply of foreign exchange available to the United States. U.S.imports create a demand for foreign exchange and make a supply of dollars available to foreigners. Generally, a nation’s exports earn the foreign currencies needed to pay for its imports.
  • The balance of payments records all international trade and financial transactions taking place between a given nation and the rest of the world. The trade balance on goods and services compares exports and imports of both goods and services.
  • The current account balance includes not only goods and services transactions but also net investment income and net transfers.
  • The capital account includes (a) the net amount of the nation’s debt forgiveness and (b) the nation’s sale of real and financial assets to people living abroad less its purchases of real and financial assets from foreigners.
  • The current account and the capital account always sum to zero. A deficit in the current account and capital account balance is offset by a surplus in the reserve account. Conversely, a surplus in the current account and capital account balance is offset by a deficit in the reserve account.
  • A balance of payment deficit is said to occur when a nation must draw down its official reserves, making inpayments to its balance of payments, in order to balance its capital and current accounts. A balance of payment surplus occurs when a nation must increase its official reserves, making outpayments from its balance of payments to balance the two accounts. The desirability of a balance of payments deficit or surplus depends on its size and its persistence.
  • Flexible or floating exchange rates between international currencies are determined by the demand for and supply of those currencies. Under flexible exchange rates a currency will depreciate or appreciate as a result of changes in tastes, relative income changes, relative price changes, relative changes in real interest rates, and speculation.
  • Fixed exchange rates requires adequate reserves to accommodate periodic payments deficits. If reserves are inadequate, nations must invoke protectionist trade policies, engage in exchange controls, or endure undesirable domestic macroeconomic adjustments.

1. Comparative Advantage #1-18
2. Balance of Payment Accounts #1-20
3. The Foreign Exchange Market #1-20



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