TOPIC 4

National and International

Accounts:
Income, Wealth, and the
Balance of Payments

1
 Introduction

• In the upcoming lectures, we will study economic

transactions between countries, how they are undertaken,
and what impact they have on the macroeconomy.
• To that end, the first task of any macroeconomist is to
understand how to measure economic activities.
• The main goal of [TOPIC 4] : How to measure the
economic activities in an open economy ?
• First, discover how international trade in goods and
services is complemented and balanced by a parallel
trade in assets
• Then, see how these transactions relate to national
income and wealth
2
 Two Main Tools

• National Income Accounting:

- records all transactions that contribute to a country’s
income and output.

• Balance of Payments Accounting:

- In an open economy, we have to account for cross-border
flows of goods/SVCs/assets.
- BOP accounting records such additional flows, and keeps
track of a nation’s indebtedness to foreign countries.

3
0401. National Income
Accounting in an Open Economy

4
 Recall: The fundamental identity in the NIA
■ The expenditure approach looks at the demand for goods: it
examines how much is spent on purchasing final goods and
services.
■ The product approach looks at the supply of goods: it
measures the value of all final goods and services produced
as output.
■ The income approach focuses on payments to owners of
factors: it tracks the amount of income they receive.

Due to the circular flow of expenditures/productions/income

in a national economy, these three approaches are
equivalent, i.e., measuring an inherently identical thing.
5
1 The National Income Accounts (a.k.a. NIPA): Basics

■ Gross National Product (GNP): the value of all final goods

and services produced by the factors of production held by
home entities and sold on the market in a given time period.
• Usually calculated by adding up the market value of all
expenditures on final output (i.e., expenditure approach).
• [Details later!] Expenditure that make up a country’s GNP
(and other measures of national products as well) is divided
into consumption, investment, government purchases, and
current account balance, denoting possible uses for which a
country’s final output is purchased.
6
1 The National Income Accounts (a.k.a. NIPA): Basics

• Since expenditures on GNP are eventually paid to the

production factors owned by home residents, GNP is a
measure of income as well.
This is why GNP is also called gross national income
(GNI) officially. Below, we will use GNP and GNI
interchangeably.

7
1 The National Income Accounts (a.k.a. NIPA): Basics

■ Gross Domestic Products (GDP)

• GNP measures the income accruing to production factors
owned by home residents, but GDP measures the value of
output produced within home country.
• In an open economy, some home GDP is paid for production
factors held by foreigners (i.e., factor SVC imported), which is
subtracted when computing home income.
• Net Factor Income from Abroad (NFIA,국외 순수취요소소득):
value of factor service exports(=payments to factors at home)
minus factor service imports(=payments to factors abroad).
• GNP = GDP +NFIA, total income earned by domestic entities
from all sources, domestic and foreign.
8
1 The National Income Accounts (a.k.a. NIPA): Basics

■ A few adjustments to GNP (or GNI) are needed so that we

have more relevant measure of national income available to
home residents (→ next slide).

9
1 The National Income Accounts (a.k.a. NIPA): Basics

■ Unilateral transfers : one party is making a transfer to the

other party, without receiving anything back.
• Ex: pension payments to retired citizens living abroad,
reparation payments, and foreign aid such as relief supplies
or funds.
■ Gross National Disposable Income (GNDI)
• Net unilateral transfers (NUT, 국외 순수취 경상이전): the
difference between UTIN and UTOUT from the perspective of
home residents (part of the home country’s income but not
part of its product)
• GNDI = GNP (or GNI) + NUT
10
1 The National Income Accounts (a.k.a. NIPA): Basics

■ Net National Income (NNI)

• Depreciation: the economic loss due to the wearing out
of machinery and structures as they are used.
• NNI = GNI - Depreciation

11
1 The National Income Accounts (a.k.a. NIPA): Basics

■ Circular flow of payments in a national economy: economic

resources are exchanged for payments through the economy

■ We will see how economic activities are measured and

recorded at various points in the circular flow.

■ Gross National Expenditure (GNE)

• The total expenditure on final goods and services by home
entities in any given period of measurement.
• GNE consists of three components: C, I, G

12
1 The National Income Accounts (a.k.a. NIPA): Basics

• C: Personal consumption expenditures (“consumption”):

total spending by private households on final goods and
services (including imports)
• I: Gross private domestic investment (“investment”): total
spending by firms or households on final goods and
services to make additions to the stock of capital.
- construction of a new house/factory, the purchase
of new equipment, and net increases in inventories
of goods held by firms

13
1 The National Income Accounts (a.k.a. NIPA): Basics

• G: Government consumption expenditures and gross

investment (“government consumption”): spending by the
public sector on final goods and services,
- It does not include any transfer payments or income
redistributions, such as Social Security or
unemployment insurance payments - these are not
purchases of goods or services.

14
2 Flow of Payments in a Closed Economy

From GNE to GDP:

• Suppose that a certain amount of GNE is measured.

• Once the spending consisting of C+I+G has been made, all
of this spending in a closed economy must be spent on the
final goods and services it produces, i.e., its gross domestic
product (GDP).
• Thus, in a closed economy, GDP equals GNE (although the
former is a product measure in contrast to the latter which is
an expenditure measure).

15
2 Flow of Payments in a Closed Economy

From GDP to GNI:

• When GDP is (produced and) sold, the payments are paid

by firms as income to production factors such as the owners
of labor, capital, and land employed by the firms.
• In a closed economy, all such income is paid to domestic
entities and thus equals the total income resources of the
economy, i.e., gross national income (GNI).

16
2 Flow of Payments in a Closed Economy

From GNI to GNE:

• There is no way for a closed economy to finance expenditure

except out of its own income, so total income is, in turn,
spent and must be the same as total expenditure.
• Therefore, once GNI is received by factors, the payments
flow next to GNE.

• This completes the circular flow in a closed economy :

expenditure is the same as product, which is the same as
income.

17
18
3 Flow of Payments in an Open Economy

■ In a closed economy, the equivalence of the three measures

hold trivially.
■ In an open economy, however, the flow of expenditure-
production-income is a lot more complicated, b/c we need to take
into account cross-border flows of expenditure/production/income.
■ To understand the circular flow in an open economy, start with
the measure of total expenditures (=GNE) in the home country.

[Recall] Gross National Expenditure (GNE)

• The total expenditure on final goods and services by home
entities in any given period of measurement.
• GNE consists of three components: C, I, G
19
3 Flow of Payments in an Open Economy

From GNE to GDP: accounting for Trade in Goods & SVCs

• GNE = an expenditure measure, GDP = a product measure.

• Due to trade, not all of the GNE payments go to GDP, and
not all of GDP payments arise from GNE.
• To adjust GNE and find its contribution to GDP, we need to
subtract the value of imports from GNE, and add the value of
exports to GNE.
• The difference between payments made for imports (IM) and
payments received for exports (EX) is called the trade
balance (TB) or net exports, which equals net payments to
domestic products.

20
3 Flow of Payments in an Open Economy

From GNE to GDP: accounting for Trade in Goods & SVCs

• Hence, GNE plus TB equals GDP, the total value of

production in the home economy.

21
3 Flow of Payments in an Open Economy

From GDP to GNI: Accounting for Trade in Factor SVCs

• We need to take into account the trade in the production

factor services (such as labor, capital, and land).
• Wage earned by home labor employed overseas, income
from FDI and overseas financial assets (e.g., foreign
securities, real estate, loans) are examples of factor SVCs
“exported” and therefore factor income from abroad.
• The value of factor service exports minus factor service
imports is known as net factor income from abroad (NFIA).

22
 3 Flow of Payments in an Open Economy

From GDP to GNI: Accounting for Trade in Factor SVCs

• Now suppose we have a certain amount of GDP.
• The Q is: what is the income of home entities for participating in
the production of goods/SVCs?
• GDP plus NFIA equal GNI(=Gross National Income), the total
income earned by domestic entities from all sources, domestic
and foreign.

23
APPLICATION
Ireland is a good example
Celtic Tiger or Tortoise?
that GDP and GNI may not
increase hand in hand.
The chart shows trends in
GDP, GNI, and NFIA in
Ireland from 1980 to 2008.
Irish GNI per capita grew
more slowly than GDP per
capita during the boom years
of the 1980s and 1990s
because an ever-larger share
of GDP was sent abroad as
net factor income to foreign
investors. Close to zero in
1980, this share had risen to
around 15% of GDP by the
year 2000 and has remained
there.
24
3 Flow of Payments in an Open Economy

From GNI to GNDI: Accounting for Transfers of Income

• The Q: does GNI measure all income that is at the disposal of

home people and firms for expenditures on goods and SVCs?
• So far, we have discussed “market” transactions in
goods/SVCs and factor income.
• There are international non-market transfers of goods/SVCs
and income, such as ODA, income remittance or “in kind”
transfers (as “gifts”) of goods, services, and monetary
payments.
• They are called unilateral transfers.

25
3 Flow of Payments in an Open Economy

From GNI to GDNI: Accounting for Transfers of Income

• [Recall] Net unilateral transfers (NUT) : unilateral transfers
received minus those it gives to the rest of the world.
• These net transfers have to be added to GNI to calculate gross
national disposable income (GNDI), representing the total
income resources available to the home country.

26
3 Flow of Payments in an Open Economy

From GNE to GNDI: a summary

27
3 Flow of Payments in an Open Economy

Current Account: Accounting for TB, NFIA, and NUT

Expenditures on final goods and SVCs in the

home country

Net payments to home arising from the full range of

international transactions in goods, services, and income

28
3 Flow of Payments in an Open Economy

What the Current Account Tells Us

Y  C  I  G  CA
• This equation is the open-economy national income
identity.
• It tells us that the current account represents the difference
between national income Y (more formally, GNDI) and
gross national expenditure GNE (or C + I + G ).
• Hence:
- GNDI is greater than GNE if and only if CA is positive, or in
surplus.
- GNDI is less than GNE if and only if CA is negative, or in
deficit.
29
 3 Flow of Payments in an Open Economy

What the Current Account Tells Us

• We define the national saving (S) as what is left over after
financing the private and gov’t consumptions out of GNDI:
S:=Y−C−G (16-6)
• Then the current account is also the difference between national
saving and investment:

- This equation is called the current account identity.

• Then the CA tells us that:
- S is greater than I if and only if CA is positive, or in surplus.
- S is less than I if and only if CA is negative, or in deficit.
30
3 Flow of Payments in an Open Economy

• A current account deficit measures:

- how much a country spends (i.e., GNE) in excess of its
income (i.e., GNDI), or equivalently,
- how little a country saves relative to its investment needs.
- Either way, a country with a current account deficit is
borrowing from abroad.
• Surpluses mean the opposite.
• Unlike a closed economy, an open economy with profitable
investment opportunities does not have to increase its saving
in order to exploit them. It can use foreign borrowing instead.
31
3 Flow of Payments in an Open Economy

What the Current Account Tells Us

• We define private saving Sp as that part of after-tax private
sector disposable income Y that is not devoted to private
consumption C. S Y T C
p
• We define government saving Sg as the difference between
tax revenue T received by the government and government
purchases G (also referred to as the government budget
surplus). Sg  T  G
• Since private saving plus government saving equals total
national saving, we have

32
3 Flow of Payments in an Open Economy

From GNDI to GNE: completing the loop

• This task is postponed until after we have discussed the

BOPs accounts in an open economy in the next section.

33
3 Flow of Payments in an Open Economy

[Case Study: Global Imbalance]

Refer to the Text Replacement.

34
35
36
0402. Balance of Payments Accounting

37
1 Components of BOP accounts

■ BOPs accounts keep track of the payments to and

receipts from foreigners.

■ Three main subaccounts

• Current account (CA)
• Financial Account (FA)
• Capital account (KA)

38
1 Components of BOP accounts

■ [Recall] Current account (CA)

• records transactions arising from the export/imports of
goods/SVCs and unilateral transfers of income.
• Subcategories:
- Trade of goods and SVCs: TB
- Factor income: NFIA
- Transfers: NUT

39
1 Components of BOP accounts

Financial Account: Accounting for Asset Transactions

■ FA account records the sales/purchases of assets between

residents and nonresidents.
• All types of asset transactions:
- financial assets such as bonds or equity, issued by any
entity, between residents and non-residents
- real assets such as residence or structures (i.e., real estate
acquired for FDI)

40
1 Components of BOP accounts
Financial Account: Accounting for Asset Transactions
• Home country’s export of assets (EXA)= the total value of
assets received by the ROW from the home country
- foreign countries pay to the home country to acquire assets
exported, and the amount received will increase resources
available for spending by the home entities.
- EXA measures the home country’s borrowing from abroad

• When the home country pays to acquire assets from the

ROW, HC is lending to abroad by “importing” assets (IMA).
- This will decrease resources available for spending on final
goods and SVCs in the HC.
41
1 Components of BOP accounts

Financial Account: Accounting for Asset Transactions

• The financial account (FA) balance = EXA- IMA

• When FA balance is positive:
EXA > IMA  Borrowing > lending  Net financial inflow
• When FA balance is negative:
EXA < IMA  Borrowing < lending  Net financial outflow

42
1 Components of BOP accounts

Capital Account: accounting for other asset transactions:

■ Capital Account (KA) records two types of asset movements

• The HC may also transfer assets as free gifts outside of the
market (e.g., the forgiveness of debts).
• Another item is the acquisition and disposal of nonfinancial,
non-produced assets:
- Tangible : land, resources, mines
- intangible : patents, copyrights, trademarks, franchises, etc.).

43
1 Components of BOP accounts

Capital Account: accounting for other asset transactions:

■ The KA balance consists of:

• Capital transfer balance:
Capital transfers received from the ROW minus capital
transfers given to the ROW
• Net capital inflow from the transactions of NFNP assets:
EXNFNPA - IMNFNPA

• KA balance = another source of resources available for

spending by the home entities

44
2 Recording BOPs in Practice:
The Principle of Double-Entry Bookkeeping
■ When recorded in the BOP accounts, every transaction (for
goods, services, factor services, or assets) has two side:
• If party A engages in a transaction with a counterparty B, then A
receives from B an item of a given value, and in return B
receives from A an item of equal value.
• Two sides of a single transaction are recorded in as both a credit
and a debit.
• Therefore, the results of a transaction appears twice: once in a
credit and once in a debit.

Q: what aspect of a transaction on which side?

45
2 The Principle of Double-Entry Bookkeeping

■ “Rules” for keeping BOPs accounts

[Rule 1] Any transaction resulting in a receipt of payment

from foreigners is entered as a credit. Any transaction
resulting in a payment to foreigners is entered as a debit.
[Rule 2] Therefore, exports of goods/SVCs/assets (= leading
to receipts of payments from foreigners) constitute credits,
and imports of goods/SVCs/assets (= leading to payments
to foreigners) constitute debits.
[Rule 3] Gifts received from foreign residents and aid
received from foreign governments are credit transactions.
Conversely, gifts and aid granted by home residents to
foreign residents are debit items.
46
Recall: which transaction in which account?

■ [Recall] Current Account, Once Again

• The CA records into the following transactions:
- Merchandise trade: Exports or imports of goods
- Services: Payments for legal assistance, tourists’
expenditures, and shipping fees
- Factor Income: international interest and dividend
payments and the earnings of domestically owned firms
operating abroad
- Unilateral Transfers

47
Recall: which transaction in which account?

■ [Recall] Financial Account, once again:

• FA measures the sales and purchases of assets to and from
foreigners.
• Financial outflow (a.k.a. capital outflow)
- A purchase of an asset from foreigners.
- The HC lends to the ROW by purchasing claims.
- The HC “imports” assets to the ROW.
• Financial inflow (a.k.a. capital inflow)
- A sales of claims to the ROW.
- The HC borrows from the ROW by selling claims.
- The HC “exports” assets to the ROW.
48
2 The Principle of Double-Entry Bookkeeping

Example 1: You(=a New Yorker) purchase a printer from

Olivetti(=an Italian company) with a $1000 check, and
the check is deposited in Citibank.

• An import of foreign good → a debit in the CA.

• Citibank has exported an asset (i.e., a bank deposit) → a
credit the FA.

49
2 The Principle of Double-Entry Bookkeeping

Example 2: You spend $200 for lunch in Paris and pay

with your AMEX card.

• An import of Foreign service → a debit in the CA.

• In return, the restaurant in Paris has acquired a claim
against AMEX company.
• The HC has “exported an asset” to France, and there is an
increase in the homes assets held by foreigners.
→ a credit is entered in the FA.

50
2 The Principle of Double-Entry Bookkeeping
Example 3: You buy a share of stock in British Petroleum
(BP) with a $95 check drawn on your money market
account. BP, in turn, deposits the $95 into its own U.S.
bank account at Wells Fargo.
• An acquisition/purchase or “import” of foreign assets → a debit in
the FA.
• In return, BNP has claim against Wells Fargo.
- The HC has “exported” an asset to UK, and there is an increase
in the homes assets held by foreigners.
- Therefore, a credit is entered in the FA.

51
2 The Principle of Double-Entry Bookkeeping

Example 4: You donate $5000 to Worldvision, so that

they purchase relief supplies and send them to Nepal
following an earthquake there.
• An “Export” of goods→ a credit in the CA.
• Given for free, the relief supplies constitute a unilateral transfer
to abroad in the CA.
- Therefore, a debit is entered in the CA.

52
2 The Principle of Double-Entry Bookkeeping
Example 5: The home gov’t decides to forgive $1
million debt owed by the Republic of Defaultoria.
• A decrease in assets held by the HC overseas?
- [Recall] An acquisition or import of assets: a FA debit.
- Then, a “negative acquisition” or “negative imports” or “export”
of assets: a FA credit.
• The outbound (non-market) capital transfer appear as a debit
in the KA.

53
3 The Fundamental BOPs Identity

■ The BOPs identity

• The BOPs accounts consist of CA, FA, and KA.
• Any international transaction automatically gives rise to
offsetting credit and debit entries in the BOPs.

CA
 + KA
 + FA
 = 0
Current account Capital account Financial account

• A credit item in one of CA, FA, or KA is automatically

accompanied by a debit item somewhere, so the sum of the
three balances ought to be 0

54
3 The Fundamental BOPs Identity

• The BOPs accounts consist of the CA, which measures

external imbalances in goods, services, factor services, and
unilateral transfers. The FA and KA measure asset trades.
• Surpluses on the CA side must be offset by deficits on the
asset side. Similarly, deficits on the current account must be
offset by surpluses on the asset side.
• By telling us how current account imbalances are financed,
the BOPs identity makes the connection between a
country’s income and spending decisions and the evolution
of that country’s wealth.
55
3 The Fundamental BOPs Identity

From GNDI to GNE: completing the circular flow

• [Recall] GNDI = GNE + TB + NFIA + NUT = GNE + CA

• In addition to GNDI, the home economy can free up (or
use up) resources available for expenditures in another
way: by engaging in sales/purchases of assets and
transfers of assets.

56
3 The Fundamental BOPs Identity

From GNDI to GNE: completing the circular flow

• Adding the FA and KA balances to GNDI will give more

accurate measure of the total resources available to the
home economy for total expenditures.

57
3 The Fundamental BOPs Identity

From GNDI to GNE: completing the circular flow

• See what the total resources available for purchases
turns out to be:

∴ In an open economy, it must be the case that the total

resources available for expenditure (=GNDI + FA + KA) equal
the total home expenditure (= GNE), since the balance of
payments sums to zero.
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59
60
 4 The External Wealth

• The flow of income and expenditure of a household affects its

stock of wealth.
• Just as a household is better off with higher wealth, all else
equal, so is a country.
• We can calculate a home country’s “net worth” or external
wealth with respect to the rest of the world (ROW) by

adding up all of the ROW assets owned by the home country

(home claims against foreigners)
and then
subtracting all of the home assets owned by ROW (foreigners’
claims against home)
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62
63
64
0403. The External Wealth

65
4 The External Wealth

The Level of External Wealth

• A country’s net worth or external wealth w.r.t. the ROW
• The level of a country’s external wealth (W) equals

66
4 The External Wealth

The Level of External Wealth

• A country’s level of external wealth (W) is also called its

net international investment position or net foreign
assets.

If W > 0, home is a net creditor country: external

assets exceed external liabilities.

If W < 0, home is a net debtor country: external

liabilities exceed external assets.

• It measures the outstanding obligations of one country

to the ROW.
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4 External Wealth

Changes in External Wealth

• There are two reasons a country’s level of external

wealth changes over time.

1. Financial flows:
acquisition/disposal of new assets/liabilities

2. Valuation effects:
changes in the value of existing assets/liabilities

68
 4 External Wealth

■ Financial flows:
• Net exports of foreign assets cause an equal decrease in
the level of external assets and hence a corresponding
decrease in external wealth.
• Net exports of home assets cause an equal increase in
the level of external liabilities and hence a corresponding
decrease in external wealth.
• Therefore, the export of assets (whether home or foreign)
is measured by the FA, and FA > 0 (i.e., a credit) decreases
external wealth.

69
4 External Wealth

■ Valuation effects:
• The value of existing external assets and liabilities may
change over time because of capital gains or losses.
• In the case of external wealth, this change in value could
be due to price effects or exchange rate effects.

70
 4 External Wealth

■ Valuation effects: an example

• Price Effect:
- Suppose the HC(= the US) purchases 100 shares of BP on
the LSE each priced ₤7, and the exchange rate is $1.8 per
₤. The external assets are worth $1,260.
- If the price of the share falls to ₤6, the 100 shares are
valued at $1,080 which is lower by $180 (= capital loss).
• Exchange Rate Effect
- Suppose the ER rises to $2 (with each share still worth ₤6).
- The total value of the shares (in the home currency) rise from
$1,080 to $1,200 (= capital gain).
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 4 External Wealth

• Adding up these two contributions to the change in external

wealth (ΔW), we find

• According to the BOP identity, −FA = CA + KA. Substituting this

into Equation (16-15), we obtain

72
 4 External Wealth

▣ Hence, a country can increase its external wealth in one of

only three ways:
• Through its own thrift (a CA surplus, so expenditure is less
than income)
• By the charity of others (a KA surplus, by receiving net gifts
of wealth)
• With the help of windfalls (having positive capital gains)

▣ Similarly, a country can reduce its external wealth by doing

any of the opposites.

73
 4 External Wealth
What External Wealth Tells Us

• External wealth include data on external assets (foreign

assets owned by the home country) and external liabilities
(home assets owned by foreigners). → it tells the net credit
or debit position of a country w.r.t. the ROW.
• A country with positive external wealth is a creditor, one with
negative external wealth is a debtor.
• CA : the imbalances in a country’s external flows of goods,
services, factor services, and income.
• The BOPs accounts : how these imbalances require
offsetting financial flows of assets between countries.

74
 4 External Wealth
What External Wealth Tells Us

• Countries with a current account surplus (deficit)

must be net buyers (sellers) of assets.
→ An increase in a country’s external wealth results from
every net import of assets; conversely, a decrease in
external wealth results from every net export of assets.
• In addition, countries can experience capital gains
or losses on their external assets and liabilities that cause
changes in external wealth.

75
 APPENDIX:

External Wealth and Total Wealth

• A country’s total wealth is the sum of:

- external wealth: amounts owed to home by foreigners (A)
minus amounts owed to foreigners by home (L)
- internal wealth: the home capital stock (all nonfinancial
assets in the home economy, denoted K).
• Financial assets owed by one home entity to another home
entity cancel out, so do not contribute to a country’s total
wealth.

76
 APPENDIX:

Total wealth = K
 + ( A - L)
Home nonfinancial assets
  
External wealth

• Changes in the value of total wealth can then be written

as follows:

77
• Additions to the domestic capital stock K are made by
domestic investment, denoted I. (Here, we ignore
depreciation of the existing K.)

• Additions to external wealth, A – L, equal net additions to

external assets minus net additions to external liabilities,
which is minus the FA balance.

78
• The BOP identity makes clear the connection between
external asset trade and activity in the current account.

• Using the BOP identity, we have CA + KA + FA = 0, i.e.,

minus the financial account –FA must equal CA + KA.
Hence we can write:

• The BOP identity makes the connection between

external asset trade and activity in the CA.

79
• Taking the connection one step further, we can use the
current account identity, S = I + CA, so that

• The message of this expression is clear. As we all probably

know from personal experience, there are only three ways to
get more (or less) wealthy: do more (or less) saving (S),
receive (or give) gifts of assets (KA), or enjoy the good (bad)
fortune of capital gains (losses) on your portfolio.

80