Question

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B ) Show how each of the following would affect the U.S. balance of payments. Include a description of the debit and credit items, and in each case identify which specific account is affected (e.g., imports of goods and services, IM; exports of assets, EX_A; and so on).

a). The U.S. central bank purchases $500 million worth of U.S. Treasury bonds from a British financial firm and sells pound sterling foreign reserves.

Answer 1

The Balance of Payment (BOP) transaction is a record of any transaction with the foreigners. This is subdivided into three parts: current account, capital account, and financial account. The fundamental relationship between these three is CA+KA=FA. Therefore, BOP is always balancing. The financial account or FA records the purchase and sale of all financial assets. The purchase of the asset is recorded as debit and sale is recorded as a credit.

In this case, the central bank purchases a US bond from a British firm is a debit and decreases financial account balance FA. This is the import of US bonds from foreigners. The sale of the Pound sterling is recorded as a credit in BOP and increases the FA account. This is the export of official reserves to foreigners.

The transaction summary is as follow:

Transaction	BOP account	Account	Credit/Debit
Purchase of US bond	FA ↓	Import of asset	Debit (-)
Sale of Pound-starling	FA ↑	Export of Asset	Credit (+)