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Chapter 12
Supplementary Notes
GNP = Expenditure on a
Country’s Goods and Services
NationalY
income =
value of
production
=
Cd + Id
+
Gd
+ EX
expenditure
on production
= (C-Cf) + (I-If) + (G-Gf) + EX
= C + I + G + EX – (Cf + If +Gf)
= C + I + G + EX – IM
= C + I + G + CA
Domestic
expenditure
Net expenditure
by foreigners
National Income Accounts: GNP
(cont.)
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
exports
Imports and exports as a percentage of GDP by country, 2000. Source: OECD
US
GNP and GDP
• Gross domestic product measures the
final value of all goods and services that are
produced within a country in a given
time period.
• GNP = GDP + factor payments from
foreign countries - factor payments to
foreign countries
• GNP = GDP + net factor income from abroad
Expenditure and Production
in an Open Economy
CA = EX – IM = Y – (C + I + G )
• When production > domestic expenditure, exports >
imports: current account > 0, trade balance > 0
– when a country exports more than it imports, it earns more
income from exports than it spends on imports
– net foreign wealth is increasing
• When production < domestic expenditure, exports <
imports: current account < 0, trade balance < 0
– when a country exports less than it imports, it earns less income
from exports than it spends on imports
– net foreign wealth is decreasing
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
US Current Account, 1960–
2004
billions of current dollars
100
0
-100 1960
1965
1970
1975
1980
1985
1990
1995
2000
-200
-300
-400
-500
-600
-700
year
Source: Bureau of Economic Analysis, US Department of Commerce
US Current Account and
Net Foreign Wealth, 1977–2003
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)
 S = Sp + Sg
• National saving = private saving + govt saving
How Is the Current Account
Related to National Saving?

CA = Y – (C + I + G )
CA = (Y – C – G ) – I
CA = S – I
current account = national saving – investment
current account = net foreign investment
Note: I is domestic investment
• A country that exports more than it imports
invests in foreign countries (by lending the CA
surplus to foreigners).
How Is the Current Account
Related to National Saving? (cont.)
CA = S – I
or
I = S – CA
• Countries can finance investment either by
saving or by acquiring foreign funds equal
to the current account deficit.
– a current account deficit or negative net
foreign investment implies a financial capital
inflow (through international borrowing).
How Is the Current Account
Related to National Saving? (cont.)
CA = Sp + Sg – I
= Sp – GD – I
• GD, Government deficit (= G – T), is negative
govt saving
• A high government deficit causes a negative
current account balance, all other things equal.
Inverse Relationship Between
Public Saving and Current
Account?
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
Balance of Payments Accounts
• A country’s balance of payments accounts
record its payments to and its receipts from
foreigners.
• Record all international transactions in goods,
services, assets
Services: travel, transportation, royalties, etc.
Assets: bank loans, deposits, stocks, bonds, etc.
US Balance of Payments Accounts,
2003 in Billions of Dollars
US Balance of Payments Accounts,
2003 in Billions of Dollars (cont.)
3 Broad 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.
Credit and Debit
• Double-entry bookkeeping: Each international
transaction enters the BoP accounts twice: once
as a credit (+) and once as a debit (-).
• Credit: sale of domestic goods, services, assets
to foreigners
• Debit: purchase of foreign goods, services,
assets from foreigners
Some useful tips
• Credit: we sell to foreigners
• Debit: we buy from foreigners
• Treat payment as if we sell the financial assets
(e.g., deposits). Receipts are treated as if our
purchase of financial assets.
• The payment part is recorded on the other side
of the BoP table.
• Exceptions: unilateral transfers, debt forgiveness
Example 1
• 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)
Credit (“sale”) of bank account by bank
(financial account)
+$30
Example 2
• 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)
Credit (“sale”) of bank account by bank
(financial account)
+$500
Example 3
• 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)
Credit (“sale”) of bank account by bank
(financial account)
+$100 M
More Terms
• Private financial transactions include direct
investment, portfolio investment (security
purchases), and bank claims and liabilities.
• Financial transactions are also classified either
short-term or long-term. Long-term means
maturity longer than or equal to 1 year.
• “Official” means assets treated as foreign
reserves. They include foreign currencies, gold,
Special Drawing Rights, and reserve position at
the IMF.
• Balance of payments = current a/c + capital a/c
+ non-reserve financial a/c
Capital inflow and outflow
• Financial (capital) inflow
– Foreigners loan to domestic citizens by acquiring domestic
assets.
– Foreign owned (sold) assets in the domestic economy are a
credit (+)
– A surplus on the financial account implies net inflow of foreign
capital.
• Financial (capital) outflow
– Domestic citizens loan to foreigners by acquiring foreign assets.
– Domestically owned (purchased) assets in foreign economies
are a debit (-)
– A deficit on the financial account implies net outflow of foreign
capital.