Download Balance of payments accounting

Chapter 12
 National Income Accounting and the Balance of
Payments
 Introduction
 The National Income Accounts
 National Income Accounting for an Open Economy
 The Balance of Payment Accounts
 Summary
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Slide 12-1
Introduction
 Macroeconomics
• It studies how economies’ overall levels of
employment, production, and growth are determined.
• It emphasizes four aspects of economic life:
– Unemployment
– Saving (national saving: household, corporate, gov’t)
– Trade imbalances
– Money and the price level (Inflation)
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Slide 12-2
Introduction


The national income accounts and the balance of payments
accounts are essential tools for studying the macroeconomics
of open economies.
National income accounting
• Records all the expenditures that contribute to a country’s
income and output
– For closed economy
– For open economy

Balance of payments accounting
• Keep track of both its payments to and its receipts from
foreigners.
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Slide 12-3
1. The National Income Accounts
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Gross national product (GNP):
• Total market value of all final products (goods and services) produced
by a country’s factors of production and sold on the market in a given
time period.
GNP identity: sum of all market expenditures on final output:
= C + I + G (for a closed economy)
Consumption
• Purchase by the private domestic residents to fulfill current wants
Investment
• Purchase by private firms to produce future output (build new plant &
buy equipment for future production, including inventory).
Government Purchases
• Purchase by governments (including central and local governments).
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Slide 12-4
The National Income Accounts
 Gross Domestic Product (GDP)
• It measures the volume of production within a
country’s borders.
• GDP = GNP - net receipts of factor income
• or GNP = GDP + net receipts of factor income
– If the factor income from abroad is larger than the
foreign factor income here, then GNP>GDP.
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Slide 12-5
The National Income Accounts
Figure 12-1: U.S. GNP and Its Components, 2000
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Slide 12-6
The National Income Accounts
 National Product and National Income
 National Income
• It is earned over a period by its factors of production.
• In principle, it must equal to the GNP.
– One person’s spending is another’s income (i.e., total
production equals total spending & also total income).
– In practice, it differs from GNP for the following
reasons.
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Slide 12-7
The National Income Accounts
 Adjustments to the GNP for National Income:
– Depreciation of capital
– It must be subtracted from GNP (to get the NNP).
– Net unilateral transfers of income
– They are part of a country’s income but are not part of its product.
– They must be added to the net national product (to get NI).
– Indirect business taxes
– Such tax as sales tax which is not distributed to the factors of
production
– They must be subtracted from GNP (to get NI).
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Slide 12-8
2. National Income Accounting
for an Open Economy

Modified the closed-economy’s national income accounting
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spent on imported foreign products.
Consumption
Investment
Government Purchases
Current Account balance (=Net Export = export - import)
• The amount net export (of goods and services) to foreigners.

• Some domestic output is exported and some domestic income
The National Income (GNP) Identity for an Open Economy
• The sum of domestic and foreigners’ expenditure on the goods
and services produced by domestic factors of production:
Y = C + I + G + (EX – IM)
(12-1)
= Cd + Id + Gd + EX (for IM = Cim + Iim + Gim)
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Slide 12-9
National Income Accounting
for an Open Economy
 An Imaginary Open Economy
• Assumptions of the model:
– An economy, called Agraria, can only produce wheat.
– Each citizen is both a consumer and a producer of wheat.
– Farmer put aside a portion of product as seed for next year’s
planting.
– The Agrarian government appropriates part of the crop to
feed its army.
– Agraria import milk from the rest of the world in exchange
for exports of wheat.
– The price of milk (per gallon) is 0.5 bushel of wheat, and at
this price Agrarians want to consume 40 gallons of milk.
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Slide 12-10
National Income Accounting
for an Open Economy
Table 12-1: National Income Accounts for Agraria, an Open Economy
(bushels of wheat)
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Slide 12-11
National Income Accounting
for an Open Economy

The Current Account and Foreign Indebtedness
• Current account (CA) balance: (= EX – IM)
– The difference between exports (of goods and services) and imports
(of goods and services).
– A country has a CA surplus when its CA > 0.
– A country has a CA deficit when its CA < 0.
• GNP identity shows why CA balance is important in open
macroeconomics.
– Change in CA is associated with changes in output. (See next slide)
– Also, CA measures the size and direction of international borrowing.
– A country’s current account balance equals the change in its net
foreign wealth.
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Slide 12-12
National Income Accounting
for an Open Economy
• CA balance is equal to the difference between GNP (national
income) and domestic residents’ total spending:
Y – (C+ I + G) = CA
– CA balance is total production less total spending, which can be
associated with changes in Y or employment.
– CA deficit (spending beyond national income) can be financed
by borrowing abroad (or reducing net foreign assets).
– Eg: Agraria imports 20 bushels of wheat (40 gallons of milk) and
exports 10 bushels of wheat. CA deficit is 10 bushels of wheat.
– It has to borrow this much from foreigners, which have to be
repaid in the future.
– CA surplus increase net foreign assets (eg. lending abroad).
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Slide 12-13
National Income Accounting
for an Open Economy
Figure 12-2: The U.S. Current Account and Net Foreign Wealth Position,
1977-2000
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Slide 12-14
National Income Accounting
for an Open Economy

Saving and the Current Account
• The GNP identity has many important implications.
• National saving (S)
– (Def.) The portion of output (Y) that is not devoted to household
consumption (C) or government purchases (G). (S= Y – C – G).
– In closed economy, national saving always equals investment (S = I).
– This can be derived from GNP identity.
– A closed economy can save only by building up its capital stock
– An open economy can save either by building up its capital stock or
by acquiring foreign wealth (S = I + CA, derived from GNP identity).
– Investment can increase not just based on domestic saving, also
based upon imported goods financed by foreign borrowing.
– Some foreign country save for this country’s investment.
– A country’s CA surplus is referred to as its net foreign investment.
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Slide 12-15
National Income Accounting
for an Open Economy

Private and Government Saving
• Private saving (Sp)
– Part of disposable income that is saved rather than consumed (Sp = Y
–T–C)
• Government savings Sg = (T-G)
• National Saving (S) defined by (Y-C-G) is the sum of Sp and Sg.
– S = (Y-C-G) = (Y-T-C) + (T-G) = Sp + Sg (= I + CA).
• (Rewrite national income identity to analyze the effect of Sg).
• Sp = I + CA – Sg = I + CA – (T – G) = I + CA + (G – T) (12-2)
– Government budget deficit (G – T) (– of government saving) is
the extent of government borrowing to finance its expenditure.
• Equation (12-2), an identity, is useful in many analysis.
– Private saving can take three forms: investment, purchase of
foreign asset, and government’s newly issued debt.
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Slide 12-16
3. The Balance of Payments Accounts
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A country’s balance of payments accounts keep track of both
its payments to and its receipts from foreigners.
• A payment is recorded as debit(-), while receipt as credit(+).
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Three types of int’l transactions recorded (3 sub-accounts).
• Exports or imports of goods or services
– Recorded in current account, as a credit(+) or a debit(-).
• Purchases or sales of financial assets (money, stocks, bond,
factory, etc) recorded in financial account.
– When a country buy foreign asset, recorded as a debit (-) in
financial account, while sales of asset recorded as a credit (+). *
• Transfers of wealth between countries (usually non-market).
– Recorded in the capital account (debt forgiveness recorded as -)
– (In some countries) included in current account as current transfer.
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Slide 12-17
The Balance of Payments Accounts
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Any international transaction automatically enters the balance
of payments twice: once as a credit (+) and once as a debit (-)
• Among the three sub-accounts.
Examples of Paired Transactions
• A U.S. citizen buys a $1000 typewriter from an Italian company,
and the Italian company deposits the $1000 in its account at
Citibank in New York.
– This transaction creates the following two offsetting entries in the
U.S. balance of payments (bookkeeping):
– It enters the U.S. CA with a negative sign (-$1000) or $1000 debit (as
a goods import).
– It enters as a $1000 credit in the U.S. financial account (as sale of
bank deposit, which is a US asset)..
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Slide 12-18
The Balance of Payments Accounts
• (Examples: cont’d)
• A U.S. citizen pays $200 for dinner at a French
restaurant in France by charging his Visa credit card.
– This transaction creates the following two offsetting
entries in the U.S. balance of payments:
– It enters the U.S. CA with a negative sign (-$200) (as a service
import).
– It shows up as a $200 credit in the U.S. financial account (as
sale of claim on US asset).
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Slide 12-19
The Balance of Payments Accounts
• (Examples: cont’d)
• A U.S. citizen buys a $95 newly issued share of stock
of a UK company by issuing a check drawn on his
account, while the UK company deposits the $95 in its
own U.S. bank account.
– That is, the U.S. trades assets for assets.
– This transaction creates the following two offsetting
entries in the U.S. balance of payments:
– It enters the U.S. financial account with a negative sign (-$95)as purchase of a share of a UK company.
– It shows up as a $95 credit in the U.S. financial account, as a
sale of claim (deposit by the UK company on US bank).
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Slide 12-20
The Balance of Payments Accounts
• (Examples: cont’d)
• A U.S. bank forgives $5000 in debt owed to it by the
government of (imaginary) Bygonia.
– This transaction creates the following two offsetting
entries in the U.S. balance of payments:
– It enters the U.S. capital account with a negative sign (-$5000),
as a capital transfer (that is, debit in capital account).
– It shows up as a $5000 credit (+) in the U.S. financial account
(as an ‘export’ of US asset, with reduction in the bank’s claim
on Bygonia) ).
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Slide 12-21
The Balance of Payments Accounts

The Fundamental Balance of Payments Identity
• Any international transaction automatically gives rise to
two offsetting entries in the balance of payments, resulting
in a fundamental identity:
Current account + financial account + capital account = 0 (12-3)
• The sum of current and capital account balance (current account
balance until 1999 in US) is the change in country’s net
receipt, therefore it should be matched by the financial account
balance (i.e., net change in financial asset) with opposite sign.
– Recall the relationship linking the current account to international
lending (or borrowing).
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Slide 12-22
The Balance of Payments Accounts
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Slide 12-23
The Balance of Payments Accounts
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Slide 12-24
The Balance of Payments Accounts
 The Current Account, Once Again
• The balance of payments accounts divide exports and
imports into three categories:
– Merchandise (goods) trade: exports or imports of goods
– Services trade:
– Payments for legal assistance, tourists’ expenditures, and
shipping fees, etc.
– Income payment
– International interest/dividend payments, earnings of domestic
firms operating abroad or individuals working abroad, etc
(kind of service trade- compensation for services)
• Unilateral transfer between countries, such as gifts.
– Not correspond to the purchase (or sale).
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Slide 12-25
The Balance of Payments Accounts
 The Capital Account
• It records asset transfers (not transactions) and tends to
be small for most countries.
 The Financial Account
• It measures the difference between sales (export) of assets
to foreigner and purchases (import) of assets from foreigner.
– Financial (capital) inflow (+)
– Borrowing from foreigners is selling them an asset (a promise
to be repaid).
– Financial (capital) outflow (-)
– Lending to foreigners is purchasing an asset from them.
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Slide 12-26
The Balance of Payments Accounts
 The Statistical Discrepancy
• Data associated with a given transaction may come
from different sources that differ in coverage, accuracy,
and timing.
– This makes the balance of payments accounts seldom
balance in practice. (‘fundamental identity’ not held).
– Account keepers force the two sides to balance by
adding an item called ‘statistical discrepancy’ to the
accounts.
– It is very difficult to allocate this discrepancy among the
current, capital, and financial accounts.
– The financial account is the most likely.
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Slide 12-27
The Balance of Payments Accounts

Official Reserve Transactions (skip)
• One type of financial account transaction is important
enough for separate discussion:
– Sale or purchase of official reserve assets by central bank.
• Central bank
– The institution responsible for managing the supply of money
• Official international reserves
– Foreign assets held by central banks as a cushion against national
economic misfortune
• Official foreign exchange intervention
– Central banks buy or sell international reserves in private asset
markets to affect macroeconomic conditions in their economies.
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Slide 12-28
The Balance of Payments Accounts
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Official foreign exchange intervention
• It is recorded in financial account as if the same transaction
•
by a private citizen.
Eg. US import of German car (Volkswagen) for $15,000,
where Volkswagen sell the dollar revenue to the Bundesbank
(German central bank).
– Bundesbank’s official dollar reserve increases.
– US BOP account: +$15,000 in financial account, with -$15,000
in current account.
– German BOP account: -$15,000 in financial account, with
+$15,000 in current account
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Slide 12-29
The Balance of Payments Accounts
• Official settlements balance
– The book-keeping offset to the balance of official
reserve transactions is called Official settlements balance
(or balance of payment).
– It is the sum of the current account balance, the capital
account balance, the nonreserve portion of the financial
account balance, and the statistical discrepancy.
– Example: The U.S. balance of payments in 2000 was -$35.6
billion, that is, the balance of official reserve transactions with
its sign reversed.
– A country with a negative balance of payments may
signal that it is running down its international reserve
assets or incurring debts to foreign monetary authorities.
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Slide 12-30
The Balance of Payments Accounts
Table 12-3: Calculating the U.S. Official Settlements Balance for 2000
(billions of dollars)
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Slide 12-31
The Balance of Payments Accounts
Table 12-3: Continued
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Slide 12-32
Summary
 A country’s GNP is equal to the income received by
its factors of production.
• GDP is equal to GNP less net receipts of factor income
from abroad, measures the output produced within a
country’s territorial borders.
 In a closed economy, GNP must be consumed,
invested, or purchased by the government.
• In an open economy, GNP equals the sum of
consumption, investment, government purchases, and
net exports of goods and services.
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Slide 12-33
Summary
 All transactions between a country and the rest of the

world are recorded in its balance of payments
accounts.
The current account equals the country’s net lending
to foreigners.
• National saving equals domestic investment plus the
current account.
• Transactions involving goods and services appear in
the current account of the balance of payments, while
international sales or purchases of assets appear in the
financial account.
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Slide 12-34
Summary
 The capital account records asset transfers and tends
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to be small in the United States.
Any current account deficit must be matched by an
equal surplus in the other two accounts of the balance
of payments, and any current account surplus by a
deficit somewhere else.
International asset transactions carried out by central
banks are included in the financial account.
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Slide 12-35