Download Slide 1

Ch. 12: National Income
Accounting and the Balance
of Payments
1
GDP vs. GNP
Gross domestic product is the final output
of a geographic area in a year, like US
GDP.
 Gross national product is the final product
of the citizens of a country in a year.
 Because international payments include
gifts, aid (unilateral transfers) and
earnings from overseas, it is better to
concentrate on GNP.

2
GDP vs. GNP
In both cases, the output produced has
to equal to the income generated:
circular flow concept.
 The output=income total will be equal to
the total expenditures.
 GDP = C + I + G + EX - IM
 GNP = C + I + G + CA

3
GDP vs. GNP
EX is exports of goods and services.
 IM is imports of goods and services.
 CA is current account balance.
 CA = EX - IM + Net unilateral transfers
+ Net transfers of factor income

4
5
Adjustment of Income and Output
Although we say output = income, in
real life there needs to be adjustments
to go from GNP to NI.
 GNP - depreciation = NNP
 NNP - Indirect business taxes = NI
 GDP - depreciation = NDP
 NDP – depreciation + Net unilateral
transfers + Net transfers of factor
income = NI

6
http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid
7
http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=6&ViewSeries=N
O&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2
007&LastYear=2010&3Place=N&Update=Update&JavaBox=no
8
National Income Accounts: GNP
9
Balance on Current Account, 2006 (Millions of USD)
http://www.bea.gov/
10
11
Imports and Exports
As a Fraction of GDP
50%
45%
Percentage of GDP
40%
35%
30%
25%
20%
15%
10%
5%
0%
Canada
imports
France
Germany
Italy
Japan
Mexico
UK
US
exports
Imports and exports as a percentage of GDP by country, 2000. Source: OECD
12
Current Account and
Macroeconomy
Y = C + I + G + CA
If CA>0, a nation increases its net foreign wealth
by consuming less than its output. The savings are
used to acquire foreign assets.
If CA<0, a nation’s net foreign wealth is reduced to
allow more consumption than production.
13
Current Account (1992-2010)
14
surplus
US Current Account As a Percentage
of GDP, 1960–2004
2%
1%
0%
-1% 1960
1965
1970
1975
1980
1985
1990
1995
2000
deficit
-2%
-3%
-4%
-5%
-6%
year
Source: Bureau of Economic Analysis, US Department of Commerce
15
US Current Account and
Net Foreign Wealth, 1977–2003
16
Saving and Current Account
Y = C + I + G + CA
Y = C + T + Sp
T + Sp = I + G + CA
T - G + Sp = I + CA
Sg + Sp = I + CA
National saving finances domestic investments
and accumulation of assets abroad.
Government deficits and low private savings,
unless financed from abroad, will lower growth.
17
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)
Sp + Sg = S
Total Saving includes saving from abroad.



18
How Is the Current Account
Related to National Saving?
CA = Y – (C + I + G )
implies
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.
19
How Is the Current Account
Related to National Saving?
CA = S – I

I = S – CA
Countries can finance investment either by
saving or by acquiring foreign funds equal to the
current account deficit.


or
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.
20
How Is the Current Account
Related to National Saving?
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.
21
US current account and public saving relative to GDP,
1960-2004
Percent of GDP
4%
2%
0%
-2%
-4%
-6%
-8%
1960
1965
1970
1975
1980
current account
1985
1990
1995
2000
public saving
Source: Congressional Budget Office, US Department of Commerce
22
Balance of Payments Accounts

A country’s balance of payments accounts
accounts for its payments to and its receipts
from foreigners.

Each international transaction enters the
accounts twice: once as a credit (+) and once as
a debit (-).
23
Balance of Payments Accounts
Payments enter as minus.
 Receipts enter as plus.
 Transactions that enter into current
account are exports, imports, transfers
and factor incomes.
 Transactions that match the above enter
into financial account - as acquiring and
reducing assets.
 Nonmarket activities are recorded in
capital account.

24
Balance of Payments 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.
25
Financial Account
An increase in US assets abroad will
enter as a minus: it is a payment.
 An increase of foreign assets in the US
will enter as a plus: it is a receipt.
 A decrease of US assets abroad will
enter as a plus.
 A decrease of foreign assets in the US
will enter as a minus.

26
Example of Balance of
Payment Accounting

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
–$30
(current account)
Increase of Japanese assets in US
+$30
(financial account)
27
Example of Balance of
Payment Accounting

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
–$500
(financial account)
Increase of Japanese assets in USA
+$500
(financial account)
28
Example of Balance of
Payment Accounting

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
–$100 M
(capital account)
Decrease of American ownership abroad
+$100 M
(financial account)
29
Exercises

How do the following affect the US Balance of
Payments?

An American buys a share of German stock, paying
by writing a check on an account with a Swiss bank.
An American buys a share of German stock, paying
by transfer of funds within an American bank.
A tourist from Detroit buys a meal in France and
pays with a traveler’s check.
An Italian buys a Dell computer and pays by a credit
card issued by an Italian bank.



30
How Do the Balance of Payments
Accounts Balance?

Due to the double entry of each transaction, the
balance of payments accounts will balance by
the following equation:
current account +
financial account +
capital account = 0
31
BOP Entries

Current Account

Exports (+)
Imports (-)
Income earned (+)
Income paid (-)
Unilateral transfers
(+/-)





Financial Account

Increase in US
assets abroad (-)
Decrease in US
assets abroad (+)
Increase in foreign
assets in US (+)
Decrease in foreign
assets in US (-)



32
Balance of Payments Accounts


Each of the 3 broad accounts are more finely
divided:
Current account: imports and exports
1.
2.
3.

merchandise (goods like DVDs)
services (payments for legal services, shipping
services, tourist meals,…)
income receipts (interest and dividend payments,
earnings of firms and workers operating in foreign
countries)
Current account: net unilateral transfers

gifts (transfers) across countries that do not
purchase a good or service nor serve as income
33
Balance of Payments Accounts

Capital account: records special asset
transfers, but this is a minor account for the US.
34
Balance of Payments Accounts

Financial account has at least
3 categories:
1.
2.
3.
Official (international) reserve assets
All other assets
Statistical discrepancy
35
Balance of Payments
The meaning of balance of payments is that
the balance sheet should always balance.
 If it doesn’t, there is a statistical discrepancy
from not collecting the data accurately or
timely.
 If private transactions don’t match because
foreigners do not want to own our assets,
governments will get involved.

36
Balance of Payments Accounts

Statistical discrepancy

Data from a transaction may come from different
sources that differ in coverage, accuracy, and timing.

The balance of payments accounts therefore seldom
balance in practice.

The statistical discrepancy is the account added to or
subtracted from the financial account to make it
balance with the current account and capital account.
37
Balance of Payments Accounts

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 owned by (sold to) foreign
central banks are a credit (+).

Official reserve assets owned by (purchased by) the
domestic central bank are a debit (-).
38
Balance of Payments Accounts

The Balance of Payments balance is (-1)
times the official reserve account.


It is the sum of the current account, the capital
account, the non-reserve portion of the financial
account, and the statistical discrepancy.
A negative official settlements balance may
indicate that a country is depleting its official
international reserve assets or may be incurring
debts to foreign central banks.
 selling foreign currency by the domestic central
bank and buying domestic assets by foreign
central banks are credits for official international
reserve assets, and therefore reduce the official
settlements balance.
39
More Exercises


Indicate the changes in US and
Canadian BOP.
An American buys an hovercraft in
Canada.
1.
2.
3.
She pays by personal check drawn
against an American Bank.
She pays with US dollars.
She exchanges USD for C$ and pays
with C$.
40
Official Reserve Transactions
An American buys a Lexus from Japan
and pays $50,000. Lexus doesn’t want
to hold USD. It exchanges it at a local
bank, which in turn exchanges it at
Japanese Central Bank.
 Japanese official assets at US have
increased.

41
Official Reserve Transactions
A Turk buys an IBM server and pays with
Turkish lira.
 With the financial meltdown (2/01), IBM does
not want to hold Turkish lira.
 IBM takes the TL to Turkish Central Bank and
gets USD.
 In the Turkish BOP, the official reserve
account shows a reduction of foreign assets
(+).
 In the US BOP, foreign ownership of US
assets has fallen (-).

42
http://www.economist.com/agenda/displaystory.cfm?story_id=3834261&fsrc=nwl
43
US Balance of Payments Accounts,
2003 in Billions of Dollars
44
US Balance of Payments Accounts,
2003 in Billions of Dollars
45
Using the web site
http://www.bea.gov/international/bp_web/simple.cfm?anon=71&table_id=1&area_id=3
Build a simple BOP account for 2010
the way the previous slide has
organized the accounts.
46
http://www.bea.gov/international/bp_web/simple.cfm?anon=71&table_id=1&area_id=3
47
2004
2005
2006
48
2004
2005
2006
49
50
2004
2005
2006
51
52
53
54
55
US Balance of Payments Accounts

The US has the most negative net foreign wealth
in the world, and so is therefore the world’s
largest debtor nation.

Its current account deficit in 2004 was $670
billion dollars, so that net foreign wealth
continued 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.
56
US Balance of Payments Accounts
57
US Balance of Payments Accounts

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 influence 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.
58
http://www.bea.gov/bea/di/intinv05_t3.xls
59
60
61
http://www.economist.
com/markets/PrinterFr
iendly.cfm?Story_ID=
3868486
62
63
http://www.bea.gov/newsreleases/international/intinv/2008/pdf/intinv07.pdf
64
http://www.economist.com/blogs/certainideasofeurope/2008/02/how_america_a
nd_europe_own_eac.cfm
A NEW REPORT by the American Chamber of Commerce to the European
Union offers a useful reminder that behind all the hoopla about China, India
and other emerging economies, ties between the rich nations of the western
world go very deep indeed.
Here are some highlights from the survey, "The Transatlantic Economy
2008", put together by scholars at Johns Hopkins University.
American assets in Britain came to a total of $2.3 trillion in 2005, which is
more than combined American assets in Asia, South America, Africa and the
Middle East.
The output of American affiliates in Belgium in 2005 came to $18.4 billion,
which is more or less the same as the combined output of American
affiliates in China and India the same year (at $18.8 billion).
American foreign direct investment in Switzerland in 2006 came to $10.4
billion, or half again as much as total American FDI in Africa and the Middle
East.
65
http://www.economist.com/blogs/certainideasofeurope/2008/02/how_america_and_
europe_own_eac.cfm
"Despite stories about European companies moving to
cheap labour markets in central Europe or Asia, most
foreigners working for European companies outside the EU
are American. European majority-owned foreign affiliates
directly employed roughly 3.5 million US workers in 2005.
The top five European employers in the US were firms from
the United Kingdom (908,000), Germany (655,000), France
(473,000), the Netherlands (442,000) and Switzerland
(389,000)."
66