Lecture 1: National Income Accounting

and the Balance of Payments

 International Macroeconomics
• International Trade studies the effects of globalization on how
the resources of a country are allocated among different
productive activities
• International Macroeconomics studies the effects of
globalization on how the aggregate spending of a country is
allocated among different types of spending
 International Macroeconomics
• International macroeconomics introduces four aspects of
economic life that are ignored in international trade:
– Unemployment
– Saving
– Trade imbalances
– Money, the price level, and exchange rates
 International Macroeconomics
• International macroeconomics tries to explain the behavior—
across countries at any given time, or across time for a given
country—of economic variables that are ignored in
international trade
• These variables are measured according to the rules of
– National income accounting, and
– Balance of payments accounting
THE NATIONAL INCOME ACCOUNTS
 The National Income Accounts: GNP
• A country’s gross national product (GNP) is the value of all
final goods and services produced by the country’s factors of
production and sold on the market in a given time period
 The National Income Accounts: GNP
• A country’s gross national product (GNP) is the value of all
final goods and services produced by the country’s factors of
production and sold on the market in a given time period
– Factors of production are the resources used in production (such as
labor, capital, and natural resources)
 The National Income Accounts : GNP
• A country’s gross national product (GNP) is the value of all
final goods and services produced by the country’s factors of
production and sold on the market in a given time period
– Final goods and services are goods and services that have been or will
be sold to their final users
– These goods will not be used to produce other goods for sale
 The National Income Accounts : GNP
• A country’s gross national product (GNP) is the value of all
final goods and services produced by the country’s factors of
production and sold on the market in a given time period
– Why are only final goods counted? Why are intermediate goods not
counted?
– To avoid counting the same productive activity multiple times
 The National Income Accounts : GNP
• A country’s gross national product (GNP) is the value of all
final goods and services produced by the country’s factors of
production and sold on the market in a given time period
– Why are only final goods counted?
– We need to measure national income. It is the expenditure of the
buyers of final goods and services that trickles down into people’s
pockets and becomes income
 The National Income Accounts : GNP
• The value of the production of all final goods and services
(GNP)
= value of total expenditure on those goods and services
= income earned by the factors of production
• So, there are three equivalent approaches to GNP
measurement: production, expenditure, and income
 The National Income Accounts : GNP
• Of the production, expenditure and income approaches to GNP
measurement, the expenditure approach is the most useful in
international macroeconomic theory
 The National Income Accounts
• Government economists and statisticians divide total
expenditure (GNP) into four types of expenditure:
– consumption (expenditure by private domestic residents),
– investment (expenditure by private firms to build new plant and
equipment for future production),
– government purchases (expenditure by the government), and
– the current account (net exports of goods and services)
 Figure 13.1 U.S. GNP and Its Components

America’s gross national product for the first quarter of 2016 can be broken down into the four
components shown.
Source: U.S. Department of Commerce, Bureau of Economic Analysis. The figure shows
2016:QI GNP and its components at an annual rate, seasonally adjusted.
 From GNP to National Income
• National Income = GNP – Depreciation + Net Unilateral
Transfers

• Depreciation is the economic loss due to the wearing out of

machinery and structures as they are used
• Gross National Product – Depreciation = Net National Product
 From GNP to National Income
• National Income = GNP – Depreciation + Net Unilateral
Transfers

• Unilateral transfers are payments made without getting

something in return
• Net Unilateral Transfers = Unilateral Transfers received from
foreigners – Unilateral Transfers paid to foreigners
 From GNP to National Income
• National Income = GNP – Depreciation + Net Unilateral
Transfers

• Examples of unilateral transfers are pension payments to

retired citizens living abroad, reparation payments, and foreign
aid. For the United States in 2012, the balance of such
payments amounted to around –$129.7 billion, representing a
0.8 percent of GNP net transfer to foreigners.
 From GNP to GDP
• GNP = GDP + net receipts of factor income from the rest of
the world.

• Gross Domestic Product (GDP) is the market value of all final

goods and services produced within the country’s borders
– Recall that GNP is the value of all final goods and services produced
by the country’s factors of production anywhere in the world
 From GNP to GDP
• GNP = GDP + net receipts of factor income from the rest of
the world.

• For the United States, net receipts of factor income are

primarily the income residents of the US earn on wealth they
hold in other countries less the payments residents of the US
make to foreign owners of wealth located in the US.
 From GNP to GDP
• GNP = GDP + net receipts of factor income from the rest of
the world.

• As a practical matter, movements in GDP and GNP usually do

not differ greatly.
– GNP tracks national income more closely than GDP does, and
national welfare depends more directly on national income than on
GDP.
– See next slide
GDP: https://fred.stlouisfed.org/series/GDPCA; GNP: https://fred.stlouisfed.org/series/GNPCA
National Income Identity for an Open Economy
• We will denote GNP by the symbol Y.
• We have seen before that government statisticians break down
total expenditure (GNP) into four categories of expenditure:
– Consumption (C)
– Investment (I)
– Government Purchases (G)
– Current Account (CA) = Exports (EX) – Imports (IM)
• Y = C + I + G + EX – IM
National Income Identity for an Open Economy
• Y = C + I + G + EX – IM

• An economy goes into a recession and suffers high

unemployment when total expenditure (GNP or Y) is too low
• In such a situation, we need to use this equation and figure out
policies that can raise C or I or G or EX – IM
 CA and International Borrowing
• CA = EX – IM

• When EX > IM, CA > 0. The country has a current account

surplus
• When EX < IM, CA < 0. The country has a current account
deficit
 CA Surplus = International Lending
• CA = EX – IM

• When EX > IM, CA > 0. The country has a current account

surplus
• This requires domestic residents to lend the amount of the
current account balance (CA) to foreign residents
– Suppose there are only two countries, Anne and Bob. Anne’s exports to Bob
equal $100 and Anne’s imports from Bob equal $75. This is possible only if Bob
borrows $25 from Anne.
 CA Deficit = International Borrowing
• CA = EX – IM

• When EX < IM, CA < 0. The country has a current account

deficit
• This requires domestic residents to borrow the amount of the
current account balance (CA) from foreign residents
– Suppose there are only two countries, Anne and Bob. Anne’s exports to Bob
equal $100 and Anne’s imports from Bob equal $125. This is possible only if Anne
borrows $25 from Bob.
 International Lending/Borrowing = International Asset
Purchases/Sales
• Borrowing money is the same as selling a financial asset
– When a corporation borrows money it does so by selling corporate
bonds, which are financial assets
• Lending money is the same as buying a financial asset
– When you buy US Treasury bonds, you are lending money to the US
government
 Net Foreign Wealth
• Net Foreign Wealth of a country = Value of domestic residents’
assets that were bought from foreign residents – Value of
foreign residents’ assets that were bought from domestic
residents
 CA > 0 means Net Foreign Wealth↑
• CA = EX – IM. So, when EX > IM, CA > 0 and the country has a
current account surplus.
• We saw that this requires domestic residents to lend the
amount of the current account balance (CA) to foreign
residents
• This lending is the same as domestic residents buying assets
from foreign residents
• Therefore, the country’s net foreign wealth increases by the
amount equal to CA
 CA < 0 means Net Foreign Wealth↓
• CA = EX – IM. So, when EX < IM, CA < 0 and the country has a
current account deficit.
• We saw that this requires domestic residents to borrow the
amount of the current account balance (CA) from foreign
residents
• This borrowing is the same as domestic residents selling assets
to foreign residents
• Therefore, the country’s net foreign wealth decreases by the
amount equal to CA
 CA and International Borrowing
• Therefore, the current account balance is a rough measure of
the increase in net foreign wealth
– So a string of current account deficits (surpluses) can lead to a
dramatic decrease (increase) in a country’s net foreign wealth

• Net Foreign Wealth is also called Net International Investment

Position
Figure 13.2 The U.S. Current Account and Net International
Investment Position, 1976–2015

A string of current account deficits starting in the early 1980s reduced America’s net foreign
wealth until, by the early 21st century, the country had accumulated a substantial net foreign
debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
CA: https://fred.stlouisfed.org/series/BPBLTT01USA637S.
IIP: https://fred.stlouisfed.org/series/IIPUSNETIA.
 Expenditure and Production in an Open Economy

Y = C + I + G +CA
CA = Y – (C + I + G )
• When domestic production (Y) > domestic expenditure (C + I + G), current account =
trade balance > 0, exports > imports
– when a country exports more than it imports, it earns more income from exports than it spends
on imports. So,
– net foreign wealth increases
• When domestic production < domestic expenditure, exports < imports, current
account = trade balance < 0
– when a country exports less than it imports, it earns less income from exports than it spends on
imports. So,
– net foreign wealth decreases

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

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National Saving = Private Saving + Public Saving
S=Y–C–G The government’s net tax revenues
S=Y–C–G–T+T are denoted T.
T = tax revenues – transfer payments
S=Y–T–C+T–G Y – T is total after-tax income or
disposable income
Private Saving: Public Saving:
Sp = Y – T – C Sg = T – G

National Saving = Private Saving + Public Saving

S = Sp + Sg
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S = Sp + Sg

13-37
 The Meaning of Saving and Investment
• Budget Surplus and Budget Deficit
– If T > G, the government runs a budget surplus because it receives
more money than it spends.
• T – G represents public saving.
– If G > T, the government runs a budget deficit because it spends more
money than it receives in tax revenue.
• Fun fact: In the 2010 fiscal year, the US federal government ran a budget
deficit of $1.3 trillion

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S = S p + Sg

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 How Is the Current Account Related to National Saving?

Y = C + I + G + CA
Y – C – I – G = CA
CA = (Y – C – G ) – I
= S – I
current account = national saving – investment
current account = net foreign investment

• A country that imports more than it exports has low national saving
relative to investment.

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CA = S – I

12-41
 How Is the Current Account Related to National Saving? (cont.)

CA = S – I or I = S – CA
• Countries can pay for investment either by using domestic saving or by
borrowing foreign funds equal to the current account deficit.
– a current account deficit implies a financial capital inflow or negative net foreign
investment.
• When S > I, then CA > 0 and net foreign investment and financial capital
outflows for the domestic economy are positive.

12-42
 How Is the Current Account Related to National Saving? (cont.)

CA = Sp + Sg – I
= Sp – government deficit – I
• Government deficit is negative government saving
– equal to G – T
• A high government deficit causes a negative current account balance, all
other things equal.

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BALANCE OF PAYMENTS ACCOUNTS

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 Balance of Payments Accounts
• A country’s balance of payments accounts summarizes all economic
transactions between domestic residents and foreign residents.
• Each international transaction enters the accounts twice:
– once as a credit, and
– once as a debit

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 Credits and Debits
• A country’s balance of payments accounts keep track of both
its payments to and its receipts from foreigners.
• Any transaction resulting in a receipt from foreigners is entered
in the balance of payments accounts as a credit.
• Any transaction resulting in a payment to foreigners is entered
as a debit.
 Credits: examples
• Sale of goods, services, and assets to foreign residents
• Receipt of income from assets bought from foreign residents
– Dividends received on foreign firms’ shares, interest paid on bonds
sold by foreign firms and governments, rent received on foreign real
estate
• Unilateral transfers received from foreign residents
 Debits: examples
• Purchase of goods, services, and assets from foreign residents
• Payment of income for domestic assets sold to foreign
residents
– Dividends paid on domestic firms’ shares, interest paid on bonds sold
by domestic firms and government, rent paid on domestic real estate
• Unilateral transfers given to foreign residents
 The Boomerang Principle
• Why does each cross-border transaction appear twice in the
balance of payments accounts, once as a credit and again as a
debit?
• Suppose you pay a foreigner in dollars (debit)
• Those dollars will one way or the other return to the US
(credit), because nobody uses dollars in the foreign country
 The Boomerang Principle
• Suppose you pay Johan in Berlin in dollars for some purchase
(debit)
• Johan uses euros, not dollars
• So he may deposit the dollars in a US bank, as savings for his
future
• Or, he may sell the dollars—in return for euros—to, say, Heidi,
who wants dollars to buy something from some American
• Either way, the dollars you paid Johan will return to the US
(credit)
 Balance of Payments Accounts (cont.)

• The balance of payment accounts are separated into 3 broad accounts:

– current account: purchases and sales of goods and services (imports and
exports).
– financial account: purchases and sales of financial assets (cross-border
borrowing and lending).
– capital account: transfers of special categories of assets (capital), typically non-
market, non-produced, or intangible assets like debt forgiveness, copyrights and
trademarks.

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 Example of Balance of
Payment Accounting
• You buy a fax machine from the Italian company Olivetti and pay with a $1,000
check.
• Olivetti deposits the funds in its bank account in Citibank, New York. Olivetti
considers the money in its bank account a financial asset worth $1,000 that it has
just bought.
Credits Debits

Fax machine purchase $1,000

(Current account, US import of a good)

Sale of bank deposit by Citibank $1,000

(Financial account, US sale of an asset)
 Example of Balance of
Payment Accounting
• You buy lunch in France and pay by credit card.
• French restaurant receives payment from your credit card company

Credits Debits

Meal purchase $200

(current account, U.S. service import)

Sale of credit card claim $200

(financial account, U.S. asset sale)
 Example of Balance of
Payment Accounting
• You buy a share of BP, a British firm.
• BP deposits the money in a U.S. bank.

Credits Debits
Stock purchase $95
(financial account, U.S. asset purchase)

Bank deposit $95

(financial account, U.S. asset sale)
 Example of Balance of
Payment Accounting
• U.S. banks forgive a $5,000 debt owed by the government of Bygonia through debt
restructuring.
• U.S. banks who hold the debt thereby reduce the debt by crediting Bygonia’s bank
accounts.

Credits Debits

Debt forgiveness $5,000

(capital account, U.S. transfer payment)

Reduction in bank’s claims (financial $5,000

account, U.S. asset sale)
 Total Credits = Total Debits
• We saw earlier that for every transaction that is recorded in
the balance of payments accounts as a credit there is another
transaction of equal value that is recorded as a debit
• Therefore, Total Credits = Total Debits
 Total Credits = Total Debits
• Total Credits = Total Debits
• Credits in Current Account + Credits in Capital Account +
Credits in Financial Account =
Debits in Current Account + Debits in Capital Account + Debits
in Financial Account
• (Credits in Current Account – Debits in Current Account) +
(Credits in Capital Account – Debits in Capital Account) =
Debits in Financial Account – Credits in Financial Account
 “Balance”
• For the Current Account and the Capital Account,
– Balance = Total Credits – Total Debits
• But for the Financial Account, it’s the reverse:
– Balance = Total Debits – Total Credits
= Lending – Borrowing
= Net Lending
= Financial outflows – financial inflows
= Net Financial Flows
 Fundamental Balance of Payments Identity
• (Credits in Current Account – Debits in Current Account) +
(Credits in Capital Account – Debits in Capital Account) =
Debits in Financial Account – Credits in Financial Account
• Current Account Balance + Capital Account Balance = Financial
Account Balance
– Recall that the financial account balance is also called net financial
flows or net lending
 Fundamental Balance of Payments Identity
• Anne and Bob are the only two countries
• Anne exports $100 of goods and services to Bob.
• In return Bob exports $75 of goods and services to Anne plus
$25 of financial assets.
The capital
• Anne’s current account balance = +$25 account has no
role in this
• Anne’s financial account balance = +$25 example.

• Bob’s current account balance = –$25 Note that the

balances must
be the same in
• Bob’s financial account balance = –$25 each country.
 Fundamental Balance of Payments Identity
• Note that Anne’s (Bob’s) net foreign wealth increases by the
amount of Anne’s (Bob’s) current account balance
• That is, the current account balance is the increase in a nation’s
net foreign wealth (or, International Investment Position)
– We will see later that a nation’s IIP can change for other reasons as
well
 Current Account Balance
• Current Account Balance = Credits – Debits
• Current Account Credits
– Exports of goods
– Exports of services
• E.g., Payment received for legal work, tourists’ spending
– Income receipts (primary income)
• E.g., interest and dividends received, profits received from businesses located
abroad but owned by domestic residents
– Unilateral transfers (gifts) received
 Current Account Balance
• Current Account Balance = Credits – Debits
• Current Account Debits
– imports of goods
– imports of services
– Income payments (primary income)
– Unilateral transfers (gifts) given
• Roughly speaking, a nation’s current account balance equals its
net exports of goods and services
 Table 13.2 U.S. Balance of
Payments Accounts for 2015
(billions of dollars)

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

Economic Analysis, June 16, 2016, release. Totals may
differ from sums because of rounding.
 Income is made up mostly
of international interest
and dividend payments
and the earnings of
domestically owned firms
NUT = gifts operating abroad.
received – gifts
given. Gifts given A negative current account
exceeded gifts
received by
is called a deficit: $440.4
$129.7 billion billion has to be made up
by borrowing.
Credits – Debits

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 Income is made up mostly
of international interest
and dividend payments
and the earnings of
domestically owned firms
NUT = gifts operating abroad.
received – gifts
given. Gifts given A negative current account
exceeded gifts
received by
is called a deficit: $440.4
$129.7 billion billion has to be made up
by borrowing.
Credits – Debits

This is credits – debits. It is

a positive amount, which
indicates that $7.0 billion
was received.
But that still leaves $433.4
that must have been
borrowed.

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 Financial Account Balance
• Financial account balance = net purchases of foreign assets by domestic residents –
net purchases of domestic assets by foreign residents
= lending – borrowing = net lending
= outflow – inflow = net financial flows
• Financial inflow (borrowing)
– When foreign residents give loans to domestic residents, they acquire/purchase financial assets
from domestic residents
– These financial inflows are credits in the financial account
– They represent an increase in the indebtedness of domestic residents
• Financial outflow (lending)
– When domestic residents give loans to foreign residents, they acquire/purchase financial assets
from foreign residents
– These financial inflows are debits in the financial account
– They represent an increase in the wealth of domestic residents
 Balance of Payments Accounts (cont.)
• Roughly speaking, a nation’s net financial flows equals the
increase in its net foreign wealth
– In 2012, US net financial flows was -$439.4 billion. As a negative
increase amounts to a decrease, this means US net foreign wealth
actually decreased in 2012
– Net foreign wealth is also called International Investment Position
 Net Errors and Omissions
• In theory, Current Account Balance + Capital Account Balance =
Financial Account Balance
• In reality, the two sides don’t match, because of imperfections
in the data
• This mismatch is called Net Errors and Omissions or Statistical
Discrepancy
• Statistically, Current Account Balance + Capital Account
Balance + Net Errors and Omissions = Financial Account
Balance
 Official Reserve Transactions
• Official (international) reserve assets: foreign assets held by central
banks to cushion against instability in international markets.
– Assets include government bonds, currency, gold and accounts at the
International Monetary Fund.
– Official reserve assets sold to foreign central banks are a credit
– Official reserve assets purchased by the domestic central bank are a debit

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 Official Settlements Balance
• Official Settlements Balance
= net purchase of international reserves by domestic central
bank – net purchase of domestic assets by foreign central
banks
= net lending to foreign residents by domestic central bank –
net lending to domestic residents by foreign central banks
= net lending to foreign residents through interventions by
central banks
 Official Settlements Balance
• Roughly speaking:
– Net financial flows is the net new lending by domestic residents to
foreign residents
• This was -$439.4 billion in 2012
– Official settlements balance is the net new lending by domestic
residents to foreign residents through transactions that involve
central banks
• This was -$389.4 billion in 2012
• This is also called net central bank financial flows
Income is made up mostly
of international interest
and dividend payments
and the earnings of
domestically owned firms
operating abroad.

A current account deficit:

$440.4 billion has to be
made up by borrowing.
This is a positive amount,
which indicates that $7.0
billion was received. That
still leaves $433.4 that
must have been borrowed.

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The net US acquisition of financial assets =
acquisition of new assets from foreign
residents – the sale (back to foreign
residents) of assets US residents had
bought from foreign residents in the past.
So, this is new US lending to foreigners.

New US borrowing from foreigners

US net borrowing from foreigners. Should

have been $433.4 billion.

Measurement is imperfect. It seems we

borrowed $6 billion more than what the
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theory implies.
All central banks combined gave US
residents a loan of $389.4 billion. So a huge
chunk of the $439.4 billion that US residents
borrowed to pay for their current account
deficit was from foreign central banks. This
is not a good sign because it suggests that
private-sector lenders would not provide
the loans needed to support the US’s
current account deficit.

This is the new lending to foreigners by the

US central bank, the Fed

This is US residents’ new borrowing from

foreign central banks.

US residents’ net asset purchases involving

central banks is 4.5 – 393.9 = – $389.4
billion. This is the official settlements
balance of the US. Informally, this too is
called balance of payments. 12-75
 US Balance of Payments Accounts
• The US has the highest negative net foreign wealth in the world, and is
therefore the world’s biggest debtor nation.
• And its current account continues to be in deficit.
– So, its net foreign wealth continues to decrease.
• The value of foreign assets held by the
US has grown since 1980, but liabilities of
the US (debt held by foreigners) has grown more quickly.
 Changes in Net Foreign Wealth (IIP)
• We have seen that a country’s net foreign wealth increases by
the amount of its net financial flows
• But net foreign wealth can change for two other reasons as
well:
– Changes in asset prices
– Changes in exchange rates
 Changes in Net Foreign Wealth (IIP)
• Changes in the market price of assets previously acquired can
alter a country’s net foreign wealth.
– When Japan’s stock market lost three-quarters of its value over the
1990s, for example, American and European owners of Japanese
shares saw the value of their claims on Japan plummet, and Japan’s
net foreign wealth increased as a result.
 Changes in Net Foreign Wealth (IIP)
• Exchange rate changes have a similar effect.
• When the dollar depreciates against foreign currencies, for
example, foreigners who hold dollar assets see their wealth fall
when measured in their home currencies.
12-80
Recall from Table 13-2 that this was the
US current account deficit in 2012.
These reflect changes in the dollar values of assets bought
(sold) by US residents from (to) foreign residents caused
by asset price changes and exchange rate changes.
12-83
Figure 13.3 U.S. Gross Foreign Assets and Liabilities, 1976-
2015

Since 1976, both the foreign assets and the liabilities of the United States have increased
sharply. But liabilities have risen more quickly, leaving the United States with a substantial net
foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2016.
 Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of dollars)
(1 of 4)
 Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of dollars)
(2 of 4)
 Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of dollars)
(3 of 4)
 Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of dollars)
(4 of 4)

r Revised n.a. Not available. . . . Not applicable (*) Value between zero and +/− $50 million
1. Represents gains or losses on foreign-currency-denominated assets and liabilities due to their revaluation at current exchange
rates.
2. Includes changes due to year-to-year shifts in the composition of reporting panels and to the incorporation of more
comprehensive survey results. Also includes capital gains and losses of direct investment affiliates and changes in positions that
cannot be allocated to financial transactions, price changes, or exchange-rate changes.
3. Financial transactions and other changes in financial derivatives positions are available only on a net basis, which is shown on
line 3; they are not separately available for gross positive fair values and gross negative fair values of financial derivatives.
4. Data are not separately available for price changes, exchange-rate changes, and changes in volume and valuation not included
elsewhere.
Note: Details may not add to totals because of rounding.
Source: U.S. Bureau of Economic Analysis.
 US Balance of Payments Accounts (cont.)

• About 70% of foreign assets held by the US are denominated in foreign currencies
and almost all of US liabilities (debt) are denominated in dollars.
• Changes in the exchange rate affect the value of net foreign wealth (gross foreign
assets minus gross foreign liabilities).
– A depreciation of the US dollar makes foreign assets held by the US more valuable, but does not
change the dollar value of dollar denominated debt.
Any Questions?

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