Chapter 12

National Income Accounting and the Balance of Payments

GNP = Expenditure on a Country’s Goods and Services
National income = value of production

Y = C + I + G + EX
d d d

expenditure on production

= (C-Cf) + (I-If) + (G-Gf) + EX = C + I + G + EX – (Cf + If +Gf) = C + I + G + EX – IM = C + I + G + CA
Domestic expenditure Net expenditure by foreigners

Fig. 12-1: U.S. GNP and Its Components

Source: U.S. Department of Commerce, Bureau of Economic Analysis

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Imports and Exports As a Fraction of GDP
50% 45% 40% Percentage of GDP 35% 30% 25% 20% 15% 10% 5% 0% Canada France Germany Italy Japan Mexico UK US

imports

exports

Imports and exports as a percentage of GDP by country, 2000. Source: OECD

GNP and GDP
• Gross domestic product measures the final value of all goods and services that are produced within a country in a given time period. • GNP = GDP + factor payments from foreign countries - factor payments to foreign countries • GNP = GDP + net factor income from abroad

Expenditure and Production in an Open Economy
CA = EX – IM = Y – (C + I + G ) • When production > domestic expenditure, exports > imports: current account > 0, trade balance > 0
– when a country exports more than it imports, it earns more income from exports than it spends on imports – net foreign wealth is increasing

• When production < domestic expenditure, exports < imports: current account < 0, trade balance < 0
– when a country exports less than it imports, it earns less income from exports than it spends on imports – net foreign wealth is decreasing

US Current Account as a Percentage of GDP, 1960–2004
2% 1%
s u p us l r

0% -1 %1 96 0 -2 % -3 % -4 % -5 % -6 % yea r S o u rce: B u reau o f E co n o m ic A n alysis, U S D ep artm en t o f C o m m erce
19 65 1 97 0 19 7 5 1 9 80 1 98 5 19 9 0 1 9 95 2 00 0

ti cf ed i

Fig. 12-2: U.S. Current Account and Net Foreign Wealth, 1976–2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007 release

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Fig. 12-3: U.S. Gross Foreign Assets and Liabilities, 1976-2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007

12-9

U.S. Current Account and Net Foreign Wealth
CA • 2006:
CA = -$788 billion (6.0% of GDP) GDP = $11,178 billion

NIIP • 2006
– NIIP = -$2,226 billion

• 2007
– NIIP = -$2,442 billion

• 2007:
CA = -$731 billion (5.3% of GDP) GDP = $13,875 billion – Why did the US NIIP change by (-)$216 billion instead of (-)$731 billion?

Saving and the Current Account
• National saving (S) = national income (Y) that is not spent on consumption (C) or government purchases (G). Y–C–G = (Y – C – T) + (T – G)

⇒ S = Sp + Sg • National saving = private saving + govt saving

How Is the Current Account Related to National Saving?

CA = Y – (C + I + G ) CA = (Y – C – G ) – I CA = S – I

current account = national saving – investment current account = net foreign investment Note: I is domestic investment

• A country that exports more than it imports invests in foreign countries (by lending the CA surplus to foreigners).

How Is the Current Account Related to National Saving? (cont.)
CA = S – I or I = S – CA
• Countries can finance investment either by saving or by acquiring foreign funds equal to the current account deficit.
– a current account deficit or negative net foreign investment implies a financial capital inflow (through international borrowing).

How Is the Current Account Related to National Saving? (cont.)
CA = Sp + Sg – I = Sp – GD – I • GD, Government deficit (= G – T), is negative govt saving • A high government deficit causes a negative current account balance, all other things equal.

Inverse Relationship Between Public Saving and Current U S c u r r e nAccount? i c s a v i n g r e l a t iv e t o G D P , t acco un t an d p u bl
1 9 6 0 -2 0 0 4
4% 2% Percent of GDP 0% -2 % -4 % -6 % -8 % 1960 1965 1970 1975 1980 1985 1990 1995 2000 c u r re n t a c c o up u b lic s a v in g nt

Source: Congressional Budget Office, US Department of Commerce

Balance of Payments Accounts
• A country’s balance of payments accounts record its payments to and its receipts from foreigners. • Record all international transactions in goods, services, assets Services: travel, transportation, royalties, etc. Assets: bank loans, deposits, stocks, bonds, etc.

Table 12-2: U.S. Balance of Payments Accounts for 2006 (billions of dollars)

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Table 12-2: U.S. Balance of Payments Accounts for 2006 (billions of dollars, cont.)

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3 Broad Accounts
• The balance of payment accounts are separated into 3 broad accounts:
– current account: accounts for flows of goods and services (imports and exports). – financial account: accounts for flows of financial assets (financial capital). – capital account: flows of special categories of assets (capital), typically non-market, non-produced, or intangible assets like debt forgiveness, copyrights and trademarks.

Credit and Debit
• Double-entry bookkeeping: Each international transaction enters the BoP accounts twice: once as a credit (+) and once as a debit (-). • Credit: sale of domestic goods, services, assets to foreigners • Debit: purchase of foreign goods, services, assets from foreigners

Some useful tips
• Credit: we sell to foreigners • Debit: we buy from foreigners • Treat payment as if we sell the financial assets (e.g., deposits). Receipts are treated as if our purchase of financial assets. • The payment part is recorded on the other side of the BoP table. • Exceptions: unilateral transfers, debt forgiveness

Example 1
• You import a DVD of Japanese anime by using your debit card. • The Japanese producer of anime deposits the funds in its bank account in San Francisco. The bank credits the account by the amount of the deposit. DVD purchase
(current account) –$30 +$30

Credit (“sale”) of bank account by bank
(financial account)

Example 2
• You invest in the Japanese stock market by buying $500 in Sony stock. • Sony deposits your funds in its Los Angeles bank account. The bank credits the account by the amount of the deposit. Purchase of stock
(financial account) –$500 +$500

Credit (“sale”) of bank account by bank
(financial account)

Example 3
• US banks forgive a $100 M debt owed by the government of Argentina through debt restructuring. • US banks who hold the debt thereby reduce the debt by crediting Argentina's bank accounts.

Debt forgiveness: non-market transfer
(capital account)

–$100 M +$100 M

Credit (“sale”) of bank account by bank
(financial account)

More Terms
• Private financial transactions include direct investment, portfolio investment (security purchases), and bank claims and liabilities. • Financial transactions are also classified either short-term or long-term. Long-term means maturity longer than or equal to 1 year. • “Official” means assets treated as foreign reserves. They include foreign currencies, gold, Special Drawing Rights, and reserve position at the IMF. • Balance of payments = current a/c + capital a/c + non-reserve financial a/c

Capital inflow and outflow
• Financial (capital) inflow
– Foreigners loan to domestic citizens by acquiring domestic assets. – This is a credit (+) transaction in the financial account. – A surplus on the financial account implies net inflow of foreign capital.

• Financial (capital) outflow
– Domestic citizens loan to foreigners by acquiring foreign assets. – This is a debit (-) transaction in the financial account. – A deficit on the financial account implies net outflow of foreign capital.

Current account
• Current account surplus (deficit) implies that the country lent to (borrowed from) the ROW in the given year.

Balance of payments
• Surplus: increase in official reserve assets • Deficit: decrease in official reserve assets • Discuss
– Problems of continuing BoP deficits – Undesirable effects of BoP surpluses

Example
• CA = -$700 billion • FA = +$500 billion (nonreserve portion) • BP = ( ) • Explain in words what international transactions occurred in this country.

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