Section 13 of Macroeconomics by Paul Krugman (Page 453 of the 3rd Edition)
Open-Economy Macroeconomics "deals with the relationships between national economies"
Key issues of Open-Econ Macro: Balance of Payments, Exchange rates, Exchange rate policy, Macroeconomic policy's relationship to exchange rates
I. Swiss Banking example:
In 2008, investors parked money in swiss banks because it's secure, despite the low interest rates
As a result, the value of the swiss franc expanded in the forex market, suppressing switzerland's ability to sell exports
Swiss national bank then sold francs to suppress the franc's values (I'm assuming this expanded the percentage of francs in other countries foreign reserves)
II. Balance of Payments Accounts
Using the analogy of a farm that, in the last year...
A. Made $100k selling artichokes
B. Spent $110k running the farm
C. Made $500 in interest from savings
D. Paid $10k in interest on mortgage
E. Took out $25k loan for farm improvements and put a percentage of it in their savings account
Their balance of payments is a 3-row, 3-column table that breaks down their sources of cash, uses of cash, and net earnings/losses (the columns) in terms of purchase/sale of goods & services, interest payments, and loans/deposits (the rows)
E.g. their uses of cash in terms of interest payments would be the $10,000 paid on mortgage. Their sources of cash in terms of loans/deposits would be the new $25k loan. The net earnings/losses in terms of goods & services is -$10k because the $100k in artichoke sales is $10k fewer than the $110k in farm expenses. And so on.
Totals of the (columns of the) farm's balance of payments are the following:
$125k in Total Sources of cash = $100k (artichoke sales) + $500 (savings account interest) + $25k (new loan)
$125k in Total Uses of cash = $110k (farm expenses) + $10k (interest paid on mortgage) + $5.5k (funds deposited from new loan)
$0 in Net Total because the Total Uses of Cash are equal to the Total Sources of Cash
Keep in mind the distinction between totals and net: "Total" is the sum of the every type of transaction (as in total uses of cash and total sources of cash) while "net" is the sum of a single type of transaction (as in net interest payments, net transactions of goods/services, and net transfers from loans). So the "net total" is the sum of every cell on the balance of payments table.
U.S. balance of payments uses a similar table (example from Bureau of Economic Analysis 2012 report):
Instead "uses of cash" and "sources of cash" it's "payments from foreigners" and "payments to foreigners"
Row 1 is goods and services purchases and sales
Row 2 is factor income (i.e. interest payments and temporary/visa works)
Row 3 is international transfers (mainly remittances like western union and other aid)
Row 4 is "official" (i.e. government) asset sales and purchases
Row 5 is private asset sales and purchases
Row 1-3 are considered the "Current Account" of the country. These are transactions that don't increase liabilities
Row 4-5 are considered the "Financial Account" or the "Capital Account"
Transactions in the Financial Account generate future liabilities, such as the purchase and sale of loans, bonds, and equities
I'm assuming that liability reversals, eg interest payments, show up in the Current Account, but I'm not sure
The "merchandise trade balance" is preferred over balance of payments by some economists. It comprises the "goods" traded in Row 1
"In the official data, the U.S. current account deficit and financial account surplus almost, but not quite, offset each other"
i.e. the US runs a deficit (negative net gains) in rows 1-3 but runs a surplus (positive net gains) in rows 4-5
in theory, the total balance of payments (sum of all rows) must be 0, but in practice inaccurate measurement-taking typically results in errors by billions of dollars
Current Account (CA) + Financial Account (FA) = 0
-> CA = -FA
-> Positive Entries on the Current Account - Negative Entries on the Current Account + Positive Entries on the Financial Account - Negative Entries on the Financial Account = 0