Download 6. Balance of Payments

Topic 6
National Income
Accounting and
the Balance
of Payments
Slides prepared by Thomas Bishop
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
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• Micro vs. Macroeconomics
• National income accounts
 GNP: measure of national income and the value of
production
 Components of GNP: C, I, G, and EX-IM
• National saving, investment, and the current
account
• Balance of payments accounts
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12-2
Micro vs. Macroeconomics
Country
Average GNP
growth rate
(1998-2007)
U.S.
3.2%
E.U.
2.0%
Japan
1.3%
China
8.9%
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• Can economic analysis
help us understand both
the interdependencies
among countries and
the reasons why their
wealth differs?
12-3
Micro vs. Macroeconomics (cont.)
• Trade is a microeconomics topic:
 How can countries make the best use of scarce
resources at a single point in time?
• Focused on how the decisions of consumers
and firms determined resource allocation and
patterns of trade.
• Free trade encourages efficient resource use.
• Government policies can create waste.
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12-4
Micro vs. Macroeconomics (cont.)
• Finance is a macroeconomics topic:
 How can economic policy ensure that factors of production
are fully employed?
 What determines how an economy’s capacity to produce
goods and services changes over time?
• Focus on economies’ overall level of employment,
production, and growth.
• Study the behavior of the economy as a whole vs.
decisions of individuals.
• Learn how the interactions of countries influence
worldwide patterns of macroeconomic activity.
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12-5
Micro vs. Macroeconomics (cont.)
•
Macro emphasizes four aspects of
economic life:
1. Unemployment: factors that cause it and steps
government can take to prevent it.
2. Savings: previously we assumed that every
country consumes an amount equal to its income.
However, a country’s savings or borrowing behavior
affects domestic employment and future levels of
national wealth.
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12-6
Micro vs. Macroeconomics (cont.)
3. Trade imbalances: previously we assumed that
the value of a country’s imports equals the value of
its exports. However, trade imbalances are a main
channel through which one country’s
macroeconomic policies affect its trading partners.
4. Money and the price level: previously we
ignored money. Goods were exchanged directly for
goods on the basis of their relative prices. In reality,
fluctuations in the supply or demand for money can
affect output and employment. And changes in one
country’s monetary policy can have impacts on
other countries.
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12-7
Micro vs. Macroeconomics (cont.)
• We begin by examining the accounting
concepts economists use to describe a
country’s level of production and its
international transactions.
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12-8
National Income Accounts
• Records the value of national income that
results from production and expenditure.
 Producers earn income from buyers who spend
money on goods and services.
 The amount of expenditure by buyers =
the amount of income for sellers =
the value of production.
 National income is often defined to be the income
earned by a nation’s factors of production.
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12-9
National Income Accounts: GNP
• Gross national product (GNP) is the value
of all final goods and services produced by a
nation’s factors of production in a given
time period.
 Factors of production are workers (labor services),
physical capital (like buildings and equipment), and
natural resources (like land and minerals).
 The value of final goods and services produced by
US-owned factors of production are counted as US
GNP.
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12-10
National Income Accounts: GNP (cont.)
•
GNP is calculated by adding the value of
expenditure on final goods and services
produced.
•
There are 4 types of expenditure:
1. Consumption (C): expenditure by domestic
consumers.
–
For the past 50 years in the U.S., C has been
roughly two-thirds of GNP.
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12-11
National Income Accounts: GNP (cont.)
2. Investment (I): expenditure by firms on
buildings and equipment.
–
Portion of GNP (e.g., steel, bricks, and labor)
used to increase the nation’s capital stock.
–
Includes firms’ purchases of inventories.
–
In U.S., I is more volatile than C. Recently, I has
fluctuated between 12% and 22% of GNP.
–
I does not include the purchase of stocks or
bonds as neither is a good or a service.
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12-12
National Income Accounts: GNP (cont.)
3. Government purchases (G): expenditure
by federal, state, or local governments on
goods and services.
–
G does not include transfer payments (e.g., SSI
or UI) as the recipients do not provide a good or
a service to the government.
–
Since late 1950s in U.S., G has been roughly
20% of GNP.
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12-13
National Income Accounts: GNP (cont.)
4. Current account balance (CA): net
expenditure by foreigners on domestic
goods and services.
–
CA = Net exports = exports – imports
–
In 2007, U.S. CA deficit was roughly 6% of GNP.
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12-14
Fig. 1: U.S. GNP and Its Components (in 2006)
Why examine the
components of GNP?
Because we cannot
understand the cause of a
recession or boom without
knowing how these
spending categories have
changed.
Source: U.S. Department of Commerce, Bureau of Economic Analysis
National Income Accounts: GNP (cont.)
• GNP measures the value of national
production and national income. Why?
 Every dollar used to purchase goods or services
automatically ends up in somebody’s pocket.
 E.g., a doctor’s visit of $450 is included in national
output (GNP) and it is included in national income.
 E.g., A firm producing $100 M of output pays most
of the proceeds (say $90 M) to its workers,
lenders, and landlord. The residual of $10 M is
profit that is paid to company owners. All of these
payments represent income to someone.
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12-16
National Income Accounts
•
GNP is one measure of national income, but
a more precise measure of national income
is GNP adjusted for the following:
1. Depreciation of physical capital results in a loss
of income to capital owners, so the amount of
depreciation is subtracted from GNP to obtain net
national product (NNP).
2. Unilateral transfers to and from other countries
can change national income: payments of
expatriate workers sent to their home countries,
foreign aid, and pension payments sent to
expatriate retirees.
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12-17
National Income Accounts (cont.)
• National income = GNP – depreciation + net
unilateral transfers
• The difference between GNP and national
income is not insignificant, but
macroeconomists are not interested in it.
• Thus, the textbook and lectures will use the
terms GNP and national income
interchangeably.
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12-18
National Income Accounts (cont.)
• Another approximate measure of national
income is gross domestic product (GDP).
• GDP measures the final value of all goods
and services that are produced within a
country’s borders in a given time period.
• GDP = GNP – payments from foreign
countries for factors of production + payments
to foreign countries for factors of production
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12-19
National Income Accounts (cont.)
• GNP includes the goods and services
produced by all Americans regardless of
where they work.
• For consistency, the outputs produced by
foreigners working in the U.S., are not
included in GNP.
• In practice, GNP and GDP are very close. But
we will focus on GNP because it is a better
measure of national income.
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12-20
GNP = Expenditure on a Country’s Goods
and Services
National
income =
value of
domestic
production
Y = Cd + Id + Gd + EX
Expenditure
on domestic
production
= (C-Cf) + (I-If) + (G-Gf) + EX
= C + I + G + EX – (Cf + If +Gf)
= C + I + G + EX – IM
= C + I + G + CA
Expenditure by domestic
individuals and institutions
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Net expenditure by foreign
individuals and institutions
12-21
Expenditure and Production in an Open
Economy
Y – (C + I + G ) = CA = EX – IM
• When production > domestic expenditure →
exports > imports: CA surplus
 The country is earning more from its exports than it
spends on imports.
 Net foreign wealth is increasing because
foreigners pay for any imports not covered by their
exports by issuing IOUs that they will eventually
have to redeem.
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12-22
Expenditure and Production in an Open
Economy (cont.)
• When production < domestic expenditure →
exports < imports: CA deficit
 The country is buying more from foreigners than it
sells to them and must somehow finance this.
 Net foreign wealth is decreasing because the
country must borrow to finance its CA deficit.
• A country’s current account balance equals
the change in its net foreign wealth.
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12-23
Expenditure and Production in an Open
Economy (cont.)
• Fig. 2 shows how a string of CA deficits can add up to
become a large foreign debt.
• U.S. had accumulated substantial foreign wealth by
the early 1980s, when a sustained CA deficit opened
up.
• In 1987, the country became a net debtor for the first
time since WWI.
• Our foreign debt has continued to grow and is now
about 20% of GNP.
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12-24
Fig. 2: U.S. Current Account and Net Foreign
Wealth, 1976–2006
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007 release
Saving and the Current Account
• National saving (S) = national income (Y)
that is not spent on C or G.
• In a closed economy, savings (S) must equal
investment (I):
Y = C + I + G
Y – C – G = I
S = I
• Any final good or service that is not purchased by
households or government must be used by firms to
produce new plant, equipment, and inventories.
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12-26
Saving and the Current Account (cont.)
• In an open economy, savings (S) need not
equal investment (I):
 Y = C + I + G + EX – IM
 Y – (C + I + G) = CA
Y – C – G = S
 S = I + CA
• An open economy can save either by building up its
capital stock or by acquiring foreign wealth (via CA
surplus), but a closed economy can only save by
building up its capital stock.
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12-27
Saving and the Current Account (cont.)
current account = net foreign investment
• Because one country’s savings can be borrowed by a
second country to increase the second country’s
capital stock, a country’s CA surplus is often called
“net foreign investment.”
• Domestic investment and foreign investment are two
different ways in which a country can use current
savings to increase its future income.
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12-28
Saving and the Current Account (cont.)
I = S – CA or CA = S - I
• Countries can finance investment either by
saving or by acquiring foreign funds equal to
the CA deficit.
 a CA deficit implies a financial asset inflow or
negative net foreign investment
• When S > I, then CA > 0, so that net foreign
investment and financial capital outflows for
the domestic economy are positive.
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12-29
Saving and the Current Account (cont.)
• We should make a distinction between private and
government saving decisions. Government saving
decisions are made with consideration of their impact
on output and employment.
Sp + Sg = S
Sp = Y –T – C ; where T = taxes - transfers
Sg = T – G
CA = Sp + Sg – I
CA = Sp – government deficit – I
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12-30
Saving and the Current Account (cont.)
CA = Sp – government deficit – I (Eq. 1)
• Government deficit is negative government saving
 equal to G – T
• A high government deficit causes a negative current
account balance when other factors remain constant.
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12-31
Case Study: Government Deficits and
Current Accounts
• Linkage between CA, I, private S, and government
deficit given by equation 1 is useful for thinking about
the impact of economic policies and events.
• In early 1980s, U.S. experienced a government deficit
and a CA deficit, giving rise to the phrase “twin
deficits.”
• CA = SP – I – (G – T)
• Equation shows that ↑(G-T) → ↓CA if private S and I
don’t change much.
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12-32
Case Study: Government Deficits and
Current Accounts (cont.)
• But twin deficits theory is misleading if changes in
government deficits lead to bigger changes in private
S and I behavior.
• E.g., European countries were forced to cut their
government budget deficits (by raising taxes and
slashing G) prior to the launch of the euro in 1999.
• Twin deficits theory predicts that EU’s CA surplus
should rise sharply in response to the fiscal change.
• However, data shows that government deficits fell by
4.5% of GNP while CA surpluses remained the same.
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12-33
Case Study: Government Deficits and
Current Accounts (cont.)
• Why? A sharp fall in private S (4% of GNP) and a
slight increase in I.
• So private savers just about neutralized the
governments efforts to raise national savings!
• Difficult to know why this occurred.
 Ricardian equivalence predicts that the private sector will
lower its own saving when governments raise taxes.
 Values of EU financial assets were rising in late 1990s
because of anticipated benefits of the euro. Thus, rising
household wealth may have reduced private S rate.
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12-34
Case Study: Government Deficits and
Current Accounts (cont.)
• CA = SP – I – (G – T)
• Because the four variables are jointly determined in
equation 1, we can never fully determine the cause of
a CA change by only looking at the equation.
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12-35
Balance of Payments Accounts
• Balance of payments (BOP) accounts are a
detailed record of the composition of the CA
balance and the many transactions that
finance it.
• An international transaction involves two
parties, and each transaction enters the
accounts twice: once as a credit (+) and once
as a debit (-).
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12-36
Balance of Payments Accounts (cont.)
• Any transaction resulting in a payment to
foreigners is entered in the BOP accounts as
a debit (-).
• Any transaction resulting in a receipt from
foreigners is entered as a credit (+).
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12-37
Balance of Payments Accounts (cont.)
•
BOP accounts are separated into 3 broad
accounts:
1. current account: accounts for flows of goods
and services (imports and exports).
2. financial account: accounts for flows of financial
assets (financial capital).
•
Its balance is the difference between a country’s
exports and imports of assets.
•
An asset is any one of the forms in which wealth can
be held (e.g., money, stocks, factories, or gov. debt).
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12-38
Balance of Payments Accounts (cont.)
3.
capital account: flows of special categories of
assets (capital): typically non-market, nonproduced, or intangible assets like debt forgiveness,
copyrights, and trademarks.
•
These international asset movements are generally very
small for the U.S.
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12-39
Example of Balance of Payments
Accounting
• You import a DVD of Japanese anime by using your
debit card.
• The Japanese producer of anime deposits the money
in its bank account in San Francisco. The bank credits
the account by the amount of the deposit.
DVD purchase
–$30
(current account)
Credit (“sale”) of deposit in account by bank
+$30
(financial account)
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12-40
Example of Balance of Payments
Accounting (cont.)
• You invest in the Japanese stock market by buying
$500 in Sony stock.
• Sony deposits the money in its Los Angeles bank
account. The bank credits the account by the amount
of the deposit.
Purchase of stock
(financial account)
Credit (“sale”) of deposit in account by bank
–$500
+$500
(financial account)
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12-41
Example of Balance of Payments
Accounting (cont.)
• U.S. banks forgive a $100 M debt owed by the
government of Argentina through debt restructuring.
• U.S. banks who hold the debt thereby reduce the debt
by crediting Argentina's bank accounts.
Debt forgiveness: non-market transfer
(capital account)
Credit (“sale”) of account by bank
(financial account)
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–$100 M
+$100 M
12-42
How Do the Balance of Payments
Accounts Balance?
• Due to the double entry of each transaction,
the BOP accounts will balance by the
following equation:
current account + capital account + financial
account = 0
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12-43
How Do the Balance of Payments
Accounts Balance? (cont.)
• Recall that the CA measures the size and
direction of international borrowing.
• CA + capital account = ∆net foreign assets
• CA + capital account = -financial account
 E.g., a country must finance its CA deficit by borrowing from
foreigners (i.e., selling financial or intangible assets).
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12-44
Balance of Payments Accounts
•
The 3 broad accounts are more finely divided:
•
Current account: imports and exports
a. goods (like consumer electronics or cars)
b. services (payments for legal services, shipping
services, tourists’ expenditures, etc.)
c. income receipts (interest and dividend payments,
earnings of firms and workers operating in
foreign countries)
•
Current account: net unilateral transfers
 gifts (transfers) across countries; payments that
do not correspond to the purchase of any good,
service, or asset.
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12-45
Balance of Payments Accounts (cont.)
• Capital account: records special transfers of assets
(typically non-market, non-produced, or intangible
assets like debt forgiveness, copyrights, and
trademarks), but this is a minor account for the U.S.
 In 2006, U.S. capital account = -$3.9 billion.
• Why are “net unilateral transfers” placed in the current
account instead of the capital account?
 Distinguish between “net unilateral transfers” (gifts) which
impact a country’s income and “non-market transfers” (like
debt forgiveness) which impact a country’s balance sheet.
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12-46
Balance of Payments Accounts (cont.)
• Financial account: the difference between sales of
domestic assets to foreigners and purchases of
foreign assets by domestic citizens.
• Financial inflow (or capital inflow)
 Foreigners loan to domestic citizens by buying domestic
assets
 Domestic assets sold to foreigners are a credit (+) because
the domestic economy acquires money during the transaction
• Financial outflow (or capital outflow)
 Domestic citizens loan to foreigners by buying foreign assets
 Foreign assets purchased by domestic citizens are a debit (-)
because the domestic economy gives up money during the
transaction
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12-47
Balance of Payments Accounts (cont.)
•
Financial account has at least
3 subcategories:
1. Official (international) reserve assets
2. All other assets
3. Statistical discrepancy
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12-48
Balance of Payments Accounts (cont.)
• Statistical discrepancy
 Data from a transaction may come from different
sources that differ in coverage, accuracy, and
timing.
 The BOP 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 CA and capital account.
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12-49
Balance of Payments Accounts (cont.)
• Official (international) reserve assets: foreign
assets held by central banks to cushion against
financial instability.
 Assets include gov. bonds, currency, gold, and accounts at
the IMF.
 Official reserve assets sold to foreign central banks are a
credit (+) because the domestic central bank can spend more
money to cushion against instability.
 Official reserve assets purchased by the domestic central
bank are a debit (-) because the domestic central bank can
spend less money to cushion against instability.
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12-50
Balance of Payments Accounts (cont.)
• Balance of official reserve transactions = net increase
in foreign official reserve claims on domestic assets –
net increase in official reserves held by the domestic
central bank.
• The negative value of the balance of official reserve
transactions is called the official settlements
balance or “balance of payments.”
 It is the sum of the current account, the capital account, the
non-reserve portion of the financial account, and the
statistical discrepancy.
 It indicates the payments gap that official reserve
transactions need to cover.
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12-51
Balance of Payments Accounts (cont.)
• A negative “balance of payments” (a deficit)
may indicate that a country:
 is depleting its international reserve assets or
 incurring large debts to foreign central banks.
• If a country faces the risk of being suddenly
cut off from foreign loans, it will want to
maintain a “war chest” of international
reserves as a precaution.
 Developing countries are sometimes in this
position.
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12-52
Table 1: U.S. Balance of Payments Accounts for 2006
(billions of $)
U.S. must cover its current + capital account deficit with a net financial
inflow (via net borrowing or sales of assets to foreigners) of $815.4 billion.
Table 1 (cont): U.S. Balance of Payments Accounts for
2006 (billions of $)
Reserves sold by the Fed
Reserves purchased by foreign
central banks
U.S. “balance of payments” = -$442.7 billion = - [$440.3 billion + $2.4 billion]
Roughly half of the U.S. current + capital account deficit was financed by foreign central banks.
U.S. Balance of Payments Accounts
• U.S. has the most negative net foreign wealth in the
world, and is therefore the world’s largest debtor
nation.
• In 2006, U.S. net foreign wealth was estimated at
-$2,539.6 billion.
 By contrast, total foreign debt owed by all Central and
Eastern European countries was about $750 billion in 2006.
 U.S. debt is just under 20% of GDP.
• And its CA deficit in 2006 was $812 billion, so net
foreign wealth continued to decrease.
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12-55
U.S. Balance of Payments Accounts (cont.)
U.S.
1976
2006
Foreign
assets
25%
104%
Liabilities
16%
123%
Note: figures expressed as a
percentage of GDP.
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• The value of foreign
assets held by the
U.S. has grown since
1980, but liabilities of
the U.S. (debt held by
foreigners) has grown
more quickly.
12-56
Fig. 3: U.S. Gross Foreign Assets and Liabilities,
1976-2006
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007
U.S. Balance of Payments Accounts (cont.)
• About 70% of foreign assets held by the U.S. are
denominated in foreign currencies and almost all of
U.S. liabilities (debt) are denominated in dollars.
• Changes in the exchange rate influence the value of
net foreign wealth (gross foreign assets minus gross
foreign liabilities).
 Appreciation of the value of foreign currencies makes foreign
assets held by the U.S. more valuable, but does not change
the dollar value of dollar-denominated debt for the U.S.
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12-58
U.S. Balance of Payments Accounts (cont.)
• E.g., a 10% depreciation in the dollar would leave
U.S. liabilities unchanged but would increase U.S.
assets (measured in dollars) by $964 billion (or 7.3%
of GDP).
• So should policy makers ignore their CA deficits and
try to devalue their currency and thereby reduce
foreign debt?
 No, such efforts would reduce foreign demand for domesticcurrency assets.
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12-59