Question

Question 4: Open Economy Macroeconomics
a. Each of the following transactions will affect the balance of payments for the United
States. Indicate which account (current account or financial account) would be affected
by each of these transactions and whether it is a credit (+) or debit (-) transaction.
i. Samsung sells $500,000 of its cellular phones to a U.S. phone service provider.
ii. Mr. Williams in the United States sends his nephew in Australia $200 as a
graduation gift.
iii. A bank in Chicago purchases a Swiss Treasury bond.
iv. Hyundai Motor, a Korean company, builds a new production plant in Alabama.
b. The United States runs a current account deficit. Is the U.S. financial account in deficit
or surplus? Explain the relationship between the two accounts.

Answer 1

The current account is a country's trade balance (exports minus imports) plus net income and direct payments. It also measures international transfers of capital - unilateral transfers, gifts to relatives, remittances, etc.

The capital account reflects net change in ownership of national assets. It includes components which affect assets and liabolities, for example, foreign investment and loans, banking and other forms of capital, as well as monetary movements or changes in the foreign exchange reserve.

Credit is what comes in (+) and debit is what goes out (-).

A. i. Samsung sells $500,000 of its cellular phones to a U.S. phone service provider.- Current Account (imports) - Debit transaction.
ii. Mr. Williams in the United States sends his nephew in Australia $200 as a graduation gift.- Current Account (gifts to relatives)- Debit transaction.
iii. A bank in Chicago purchases a Swiss Treasury bond.- Capital account (asset) - Debit transaction.
iv. Hyundai Motor, a Korean company, builds a new production plant in Alabama.- Capital account (FDI)- Credit transaction.

B. The current account deficit is a measurement of a country's trade where the value of the goods and services it imports exceeds the value of the products it exports. It implies that the Current Account of US has a negative final balance (debit). The financial account is in surplus.

The financial account is a large component of the balance of payments. It adds to the balance of payments when it's positive, or when foreign money is flowing into the country to purchase assets. It subtracts from the balance of payments when domestic money is flowing out of the country to purchase foreign assets. That is, is is balancing in nature and its balance is in opposite of the net balance of current and capital account.