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Section 1 The Balance of Payments 1 Content • • • • • • Objectives The National Income Accounts S, I, and CA The BOP Accounts Bookkeeping Summary 2 Objectives • To review national income accounting – The national income accounts record all the income and expenditures of a country. • To review balance of payments accounting – The balance of payments accounts record all international transactions of a country. 3 The National Income Accounts • Gross National Product (GNP) – The value of all final goods and services produced by a country’s factors of production and sold on the market in a given time period. – The Output of a country in a given time period. 4 The National Income Accounts • Gross Domestic Product (GDP) – The value of all final goods and services produced by the factors of production within a country’s borders. – GDP = GNP - net receipts of factor income from the rest of the world. 5 The National Income Accounts • The National Income Identity Y = C + I + G + EX – IM where: • • • • • • Y is GNP C is consumption I is investment G is government purchases EX is exports IM is imports 6 The National Income Accounts • Consumption (C) – The share of GNP consumed by the private sector. • Investment (I) – The share of GNP used by private firms to produce future output. • Government Purchases (G) – The share of GNP used by federal, state, or local governments 7 The National Income Accounts • Exports (EX) – • The share of GNP exported to the rest of the world. Imports (IM) – The share of GNP imported from the rest of the world. 8 The National Income Accounts • The Current Account (CA) – – – – CA = EX – IM A country has a CA surplus when its CA > 0. A country has a CA deficit when its CA < 0. CA measures the size and direction of international borrowing. – A country’s current account balance equals the change in its net foreign wealth. 9 Figure 12-1: U.S. GNP and Its Components, 2000 10 Figure 12-2: The U.S. Current Account and Net Foreign Wealth Position, 1977-2000 11 US Current Account and Trade Balance (as a share of GDP) Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis. Note: The vertical bars indicate periods of recession as defined by the National Bureau of Economic Research 12 S, I, and CA • National Savings (S) – The share of GNP that is not devoted to household consumption or government purchases. – S=Y–C–G – S = PS + GS 13 S, I, and CA • Private Savings (PS) – The share of disposable income saved. – PS = Y – T – C • Government Savings – The share of tax revenues (T) saved. – GS = T – G – Government budget deficit: G – T 14 S, I, and CA • The key relation: I = S – CA – – – – – S = PS + GS PS = Y – T – C GS = T – G CA = EX – IM Y = C + I + G + EX - IM 15 S, I, and CA • The current account is a measure of foreign savings at home. • Are current account deficits good? • The twin deficits hypothesis. 16 The BOP Accounts • The Balance of Payments (BOP) accounts is a record of all transactions between a country and the rest of the world. • Every transaction enters the BOP twice: once as a credit (+) and once as a debit (-). 17 The BOP Accounts • The Current Account (CA) – The current account divides exports and imports into three categories: • Merchandise trade • Services • Interest and dividend income 18 The BOP Accounts • The Capital and Financial Account (KA) – The capital and financial account records the exports and imports of assets. – Capital inflow: An export of assets. – Capital outflow: An import of assets. 19 The BOP Accounts • Official Reserve Transactions (ΔRFX) – Official international reserves • Foreign assets held by central banks. – Official foreign exchange intervention • Exchange rate intervention often requires to alter the amount of official reserves. 20 The BOP Accounts • The key relation: CA + KA = ΔRFX • This is an accounting identity • Accounting: – Exports are recorded as credits (+) in CA, KA – Imports are recorded as debits (-) in CA, KA 21 Bookkeeping • Example 1: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. • Entries in the U.S. balance of payments: – Purchases (imports) typewriter: Debit CA of $1000. – Sells (exports) asset: Credit to KA of $1000. – CA (-$1000) + KA (+$1000) = 0 22 Bookkeeping • Example 2: A U.S. citizen buys a $95 newly issued share of stock in the United Kingdom oil giant British Petroleum (BP) by using a check drawn on his stockbroker money market account. BP deposits the $95 in its own U.S. bank account at Second Bank of Chicago. • Entries in the U.S. balance of payments: – Purchases (imports) share: Debit to KA of $95. – Sells (exports) assets: Credit to KA of $95. – CA ($0) + KA (+$95 -$95) = 0 23 Bookkeeping • A reduction of official reserves: ΔRFX < 0 – An export of assets by the central bank. • An increase of official reserves: ΔRFX > 0 – An import of assets by the central bank. • So, changes in RFX similar to transactions in KA. 24 Summary • GNP measures the income and production of a country’s factors of production. • GDP measures the output produced within a country’s territorial borders. • Y = C + I + G + EX – IM • I = PS + GS – CA • The current account is a measure of the country’s net lending to foreigners. 25 Summary • The current account records net exports of goods and services. • The capital and financial accounts record net exports of assets. • BOP = CA + KA = ΔRFX • Exports are recorded as a credit. • Imports are recorded as a debit. 26