Page 455 - Krugmans Economics for AP Text Book_Neat

goods alone—not including services. Economists sometimes focus on the merchandise
A country’s balance of payments
trade balance, even though it’s an incomplete measure, because data on international
on the financial account, or simply
trade in services aren’t as accurate as data on trade in physical goods, and they are also
the financial account, is the difference
slower to arrive. between its sales of assets to
The current account, as we’ve just learned, consists of international transactions foreigners and its purchases of assets
that don’t create liabilities. Transactions that involve the sale or purchase of assets, and from foreigners during a given period.
therefore do create future liabilities, are considered part of the balance of payments
on the financial account, or the financial account for short. (Until a few years ago,
economists often referred to the financial account as the capital account. We’ll use the
modern term, but you may run across the older term.)
So how does it all add up? The shaded rows of Table 41.2 show the bottom lines: the
overall U.S. current account and financial account for 2008. As you can see, in 2008, Section 8 The Open Economy: International Trade and Finance
the United States ran a current account deficit: the amount it paid to foreigners for
goods, services, factors, and transfers was greater than the amount it received. Simulta-
neously, it ran a financial account surplus: the value of the assets it sold to foreigners
was greater than the value of the assets it bought from foreigners.
In the official data, the U.S. current account deficit and financial account surplus
almost, but not quite, offset each other: the financial account surplus was $167 bil-
lion smaller than the current account deficit. But that’s just a statistical error, re-
flecting the imperfection of official data. (And a $167 billion error when you’re
measuring inflows and outflows of $3.5 trillion isn’t bad!) In fact, it’s a basic rule of
balance of payments accounting that the current account and the financial account
must sum to zero:

(41-1) Current account (CA) + Financial account (FA) = 0

or

CA =−FA

Why must Equation 41-1 be true? We already saw the fundamental explanation in
Table 41.1, which showed the accounts of the Costa family: in total, the sources of
cash must equal the uses of cash. The same applies to balance of payments accounts.
Figure 41.1 on the next page, a variant on the circular -flow diagram we have found
useful in discussing domestic macroeconomics, may help you visualize how this
adding up works.
Instead of showing the flow of money within a national economy, Figure 41.1 shows
the flow of money between national economies. Money flows into the United States
from the rest of the world as payment for U.S. exports of goods and services, as pay-
ment for the use of U.S.-owned factors of production, and
as transfer payments. These flows (indicated by the lower
green arrow) are the positive components of the U.S. cur-
rent account. Money also flows into the United States
from foreigners who purchase U.S. assets (as shown by the
lower red arrow)—the positive component of the U.S. fi-
nancial account.
At the same time, money flows from the United States to
the rest of the world as payment for U.S. imports of goods
and services, as payment for the use of foreign -owned fac-
tors of production, and as transfer payments. These flows,
indicated by the upper green arrow, are the negative compo-
nents of the U.S. current account. Money also flows from
the United States to purchase foreign assets, as shown by
the upper red arrow—the negative component of the U.S. fi-
nancial account. As in all circular - flow diagrams, the flow David Horsey
into a box and the flow out of a box are equal. This means

module 41 Capital Flows and the Balance of Payments 413