1 Ch. 12: National Income Accounting and the Balance of Payments

11

Ch. 12: National Income Ch. 12: National Income Accounting and the Balance Accounting and the Balance

of Paymentsof Payments

22

GDP vs. GNPGDP vs. GNPGross domestic product is the final output Gross domestic product is the final output

of a geographic area in a year, like US of a geographic area in a year, like US GDP.GDP.

Gross national product is the final product Gross national product is the final product of the citizens of a country in a year.of the citizens of a country in a year.

Because international payments include Because international payments include gifts, aid (unilateral transfers) and gifts, aid (unilateral transfers) and earnings from overseas, it is better to earnings from overseas, it is better to concentrate on GNP.concentrate on GNP.

33

GDP vs. GNPGDP vs. GNP In both cases, the output produced has In both cases, the output produced has

to equal to the income generated: to equal to the income generated: circular flow concept.circular flow concept.

The output=income total will be equal to The output=income total will be equal to the total expenditures.the total expenditures.

GDP = C + I + G + EX - IMGDP = C + I + G + EX - IMGNP = C + I + G + CAGNP = C + I + G + CA

44

GDP vs. GNPGDP vs. GNP

EX is exports of goods and services.EX is exports of goods and services. IM is imports of goods and services.IM is imports of goods and services.CA is current account balance.CA is current account balance.CA = EX - IM + Net unilateral transfers CA = EX - IM + Net unilateral transfers

+ Net transfers of factor income+ Net transfers of factor income

55

66

Adjustment of Income and OutputAdjustment of Income and OutputAlthough we say output = income, in Although we say output = income, in

real life there needs to be adjustments real life there needs to be adjustments to go from GNP to NI.to go from GNP to NI.

GNP - depreciation = NNPGNP - depreciation = NNPNNP - Indirect business taxes = NINNP - Indirect business taxes = NIGDP - depreciation = NDPGDP - depreciation = NDPNDP – depreciation + Net unilateral NDP – depreciation + Net unilateral

transfers + Net transfers of factor transfers + Net transfers of factor income = NIincome = NI

77

http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid

88http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=6&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2007&LastYear=2010&3Place=N&Update=Update&JavaBox=no

99

National Income Accounts: GNPNational Income Accounts: GNP

1010http://www.bea.gov/

Balance on Current Account, 2006 (Millions of USD)

1111

1212

Imports and Exports Imports and Exports As a Fraction of GDPAs a Fraction of GDP

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Canada France Germany Italy Japan Mexico UK US

Per

cen

tag

e o

f G

DP

imports exports

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Canada France Germany Italy Japan Mexico UK US

Per

cen

tag

e o

f G

DP

imports exports

Imports and exports as a percentage of GDP by country, 2000. Source: OECD

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Current Account and Current Account and MacroeconomyMacroeconomy

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.

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Current Account (1992-2010)Current Account (1992-2010)

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US Current Account As a Percentage US Current Account As a Percentage of GDP, 1960–2004of GDP, 1960–2004

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

1960 1965 1970 1975 1980 1985 1990 1995 2000

year

Source: Bureau of Economic Analysis, US Department of Commerce

defic

itsu

rplu

s

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US Current Account and US Current Account and Net Foreign Wealth, 1977–2003Net Foreign Wealth, 1977–2003

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Saving and Current AccountSaving and Current Account

Y = C + I + G + CAY = C + T + Sp

T + Sp = I + G + CAT - G + Sp = I + CASg + Sp = I + CANational saving finances domestic investmentsand accumulation of assets abroad.Government deficits and low private savings, unless financed from abroad, will lower growth.

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Saving and the Current AccountSaving and the Current Account

National saving ( (SS) = national income () = national income (YY) that ) that is not spent on consumption (is not spent on consumption (CC) or government ) or government purchases (purchases (GG).).

Y – C – GY – C – G ((Y – C – TY – C – T)) + + ((T – GT – G) ) SSpp + S + Sg g = S= S

Total Saving includes saving from abroad.

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How Is the Current Account How Is the Current Account Related to National Saving?Related to National Saving?

CACA = = YY – ( – (CC + + II + + G G ))

impliesimplies

CACA = ( = (YY – – CC – – G G ) – ) – II

= = SS – – II

current accountcurrent account = = national saving – investmentnational saving – investment

current account current account == net foreign investment net foreign investment

A country that imports more than it exports has A country that imports more than it exports has low national saving relative to investment. low national saving relative to investment.

2020

How Is the Current Account How Is the Current Account Related to National Saving? Related to National Saving?

CACA = = SS – – I or I or I I = = SS – – CACA

Countries can finance investment either by Countries can finance investment either by saving or by acquiring foreign funds equal to the saving or by acquiring foreign funds equal to the current account deficit.current account deficit.

a current account deficit implies a financial capital a current account deficit implies a financial capital inflow or negative net foreign investment.inflow or negative net foreign investment.

When When S > IS > I, then , then CA > 0 CA > 0 and net foreign and net foreign investment and financial capital outflows for the investment and financial capital outflows for the domestic economy are positive.domestic economy are positive.

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How Is the Current Account How Is the Current Account Related to National Saving? Related to National Saving?

CACA = = SSpp + + SSgg – – II

= = SSpp – government deficit – – government deficit – II

Government deficit is negative government Government deficit is negative government savingsaving equal to G – T equal to G – T

A high government deficit causes a A high government deficit causes a negative current account balance, all other negative current account balance, all other things equal. things equal.

2222

Source: Congressional Budget Office, US Department of Commerce

US current account and public saving relative to GDP, 1960-2004

-8%

-6%

-4%

-2%

0%

2%

4%

1960 1965 1970 1975 1980 1985 1990 1995 2000

Perc

ent o

f GDP

current account public saving

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Balance of Payments AccountsBalance of Payments Accounts

A country’s balance of payments accounts A country’s balance of payments accounts accounts for its payments to and its receipts accounts for its payments to and its receipts from foreigners.from foreigners.

Each international transaction enters the Each international transaction enters the accounts twice: once as a credit (+) and once as accounts twice: once as a credit (+) and once as a debit (-).a debit (-).

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Balance of Payments AccountsBalance of Payments AccountsPayments enter as minus.Payments enter as minus.Receipts enter as plus.Receipts enter as plus.Transactions that enter into current Transactions that enter into current

account are exports, imports, transfers account are exports, imports, transfers and factor incomes.and factor incomes.

Transactions that match the above Transactions that match the above enter into financial account - as enter into financial account - as acquiring and reducing assets.acquiring and reducing assets.

Nonmarket activities are recorded in Nonmarket activities are recorded in capital account.capital account.

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The balance of payment accounts are separated The balance of payment accounts are separated into 3 broad accounts:into 3 broad accounts:

current accountcurrent account: accounts for flows of goods and : accounts for flows of goods and services (imports and exports).services (imports and exports).

financial accountfinancial account: accounts for flows of financial : accounts for flows of financial assets (financial capital).assets (financial capital).

capital accountcapital account: flows of special categories of : flows of special categories of assets (capital), typically non-market, non-produced, assets (capital), typically non-market, non-produced, or intangible assets like debt forgiveness, copyrights or intangible assets like debt forgiveness, copyrights and trademarks.and trademarks.

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Financial AccountFinancial AccountAn increase in US assets abroad will An increase in US assets abroad will

enter as a minus: it is a payment.enter as a minus: it is a payment.An increase of foreign assets in the US An increase of foreign assets in the US

will enter as a plus: it is a receipt.will enter as a plus: it is a receipt.A decrease of US assets abroad will A decrease of US assets abroad will

enter as a plus.enter as a plus.A decrease of foreign assets in the US A decrease of foreign assets in the US

will enter as a minus.will enter as a minus.

2727

Example of Balance of Example of Balance of Payment AccountingPayment Accounting

You import a DVD of Japanese anime by using your You import a DVD of Japanese anime by using your debit card. debit card.

The Japanese producer of anime deposits the funds in The Japanese producer of anime deposits the funds in its bank account in San Francisco. The bank credits the its bank account in San Francisco. The bank credits the account by the amount of the deposit.account by the amount of the deposit.

DVD purchaseDVD purchase(current account)(current account)

––$30$30

Increase of Japanese assets in US Increase of Japanese assets in US (financial account)(financial account)

+$30+$30

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You invest in the Japanese stock market by buying $500 You invest in the Japanese stock market by buying $500 in Sony stock.in Sony stock.

Sony deposits your funds in its Los Angeles bank Sony deposits your funds in its Los Angeles bank account. The bank credits the account by the amount of account. The bank credits the account by the amount of the deposit.the deposit.

Purchase of stock Purchase of stock (financial account)(financial account)

––$500$500

Increase of Japanese assets in USAIncrease of Japanese assets in USA(financial account)(financial account)

+$500+$500

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US banks forgive a $100 M debt owed by the US banks forgive a $100 M debt owed by the government of Argentina through debt restructuring.government of Argentina through debt restructuring.

US banks who hold the debt thereby reduce the debt by US banks who hold the debt thereby reduce the debt by crediting Argentina's bank accounts.crediting Argentina's bank accounts.

Debt forgiveness: non-market transferDebt forgiveness: non-market transfer(capital account) (capital account)

––$100 M$100 M

Decrease of American ownership abroad Decrease of American ownership abroad (financial account) (financial account)

+$100 M+$100 M

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ExercisesExercisesHow do the following affect the US Balance of How do the following affect the US Balance of

Payments?Payments? An American buys a share of German stock, paying An American buys a share of German stock, paying

by writing a check on an account with a Swiss bank.by writing a check on an account with a Swiss bank. An American buys a share of German stock, paying An American buys a share of German stock, paying

by transfer of funds within an American bank.by transfer of funds within an American bank. A tourist from Detroit buys a meal in France and A tourist from Detroit buys a meal in France and

pays with a traveler’s check.pays with a traveler’s check. An Italian buys a Dell computer and pays by a credit An Italian buys a Dell computer and pays by a credit

card issued by an Italian bank.card issued by an Italian bank.

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How Do the Balance of Payments How Do the Balance of Payments Accounts Balance?Accounts Balance?

Due to the double entry of each transaction, the Due to the double entry of each transaction, the balance of payments accounts will balance by balance of payments accounts will balance by the following equation:the following equation:

current account + current account +

financial account + financial account +

capital account = 0capital account = 0

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BOP EntriesBOP EntriesCurrent AccountCurrent Account Exports (+)Exports (+) Imports (-)Imports (-) Income earned (+)Income earned (+) Income paid (-)Income paid (-) Unilateral transfers Unilateral transfers

(+/-)(+/-)

Financial AccountFinancial Account Increase in US Increase in US

assets abroad (-)assets abroad (-) Decrease in US Decrease in US

assets abroad (+)assets abroad (+) Increase in foreign Increase in foreign

assets in US (+)assets in US (+) Decrease in foreign Decrease in foreign

assets in US (-)assets in US (-)

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Balance of Payments AccountsBalance of Payments Accounts Each of the 3 broad accounts are more finely Each of the 3 broad accounts are more finely

divided:divided: Current accountCurrent account: imports and exports : imports and exports

1.1. merchandise (goods like DVDs) merchandise (goods like DVDs) 2.2. services (payments for legal services, shipping services (payments for legal services, shipping

services, tourist meals,…)services, tourist meals,…)3.3. income receipts (interest and dividend payments, income receipts (interest and dividend payments,

earnings of firms and workers operating in foreign earnings of firms and workers operating in foreign countries)countries)

Current accountCurrent account: : net unilateral transfers net unilateral transfers gifts (transfers) across countries that do not gifts (transfers) across countries that do not

purchase a good or service nor serve as incomepurchase a good or service nor serve as income

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Capital accountCapital account: records special asset : records special asset transfers, but this is a minor account for the US.transfers, but this is a minor account for the US.

3535


Financial accountFinancial account has at least has at least 3 categories:3 categories:

1.1. Official (international) reserve assets Official (international) reserve assets

2.2. All other assetsAll other assets

3.3. Statistical discrepancyStatistical discrepancy

3636

Balance of PaymentsBalance of PaymentsThe meaning of balance of payments is that The meaning of balance of payments is that

the balance sheet should always balance.the balance sheet should always balance. If it doesn’t, there is a statistical discrepancy If it doesn’t, there is a statistical discrepancy

from not collecting the data accurately or from not collecting the data accurately or timely.timely.

If private transactions don’t match because If private transactions don’t match because foreigners do not want to own our assets, foreigners do not want to own our assets, governments will get involved.governments will get involved.

3737


Statistical discrepancyStatistical discrepancy

Data from a transaction may come from different Data from a transaction may come from different sources that differ in coverage, accuracy, and timing. sources that differ in coverage, accuracy, and timing.

The balance of payments accounts therefore seldom The balance of payments accounts therefore seldom balance in practice.balance in practice.

The statistical discrepancy is the account added to or The statistical discrepancy is the account added to or subtracted from the financial account to make it subtracted from the financial account to make it balance with the current account and capital account.balance with the current account and capital account.

3838


Official (international) reserve assetsOfficial (international) reserve assets: foreign : foreign assets held by central banks to cushion against assets held by central banks to cushion against instability in international markets.instability in international markets. Assets include government bonds, currency, gold and Assets include government bonds, currency, gold and

accounts at the International Monetary Fund.accounts at the International Monetary Fund.

Official reserve assets owned by (sold to) foreign Official reserve assets owned by (sold to) foreign central banks are a credit (+).central banks are a credit (+).

Official reserve assets owned by (purchased by) the Official reserve assets owned by (purchased by) the domestic central bank are a debit (-).domestic central bank are a debit (-).

3939


The The Balance of Payments balanceBalance of Payments balance is (-1) is (-1) times the official reserve account.times the official reserve account. It is the sum of the current account, the capital It is the sum of the current account, the capital

account, the non-reserve portion of the financial account, the non-reserve portion of the financial account, and the statistical discrepancy.account, and the statistical discrepancy.

A negative official settlements balance may A negative official settlements balance may indicate that a country is depleting its official indicate that a country is depleting its official international reserve assets or may be incurring international reserve assets or may be incurring debts to foreign central banks.debts to foreign central banks.selling foreign currency by the domestic central selling foreign currency by the domestic central

bank and buying domestic assets by foreign bank and buying domestic assets by foreign central banks are credits for official international central banks are credits for official international reserve assets, and therefore reduce the official reserve assets, and therefore reduce the official settlements balance.settlements balance.

4040

More ExercisesMore Exercises Indicate the changes in US and Indicate the changes in US and

Canadian BOP.Canadian BOP. An American buys an hovercraft in An American buys an hovercraft in

Canada.Canada.1.1. She pays by personal check drawn She pays by personal check drawn

against an American Bank.against an American Bank.

2.2. She pays with US dollars.She pays with US dollars.

3.3. She exchanges USD for C$ and pays She exchanges USD for C$ and pays with C$.with C$.

4141

Official Reserve TransactionsOfficial Reserve Transactions

An American buys a Lexus from Japan An American buys a Lexus from Japan and pays $50,000. Lexus doesn’t want and pays $50,000. Lexus doesn’t want to hold USD. It exchanges it at a local to hold USD. It exchanges it at a local bank, which in turn exchanges it at bank, which in turn exchanges it at Japanese Central Bank.Japanese Central Bank.

Japanese official assets at US have Japanese official assets at US have increased.increased.

4242

Official Reserve TransactionsOfficial Reserve TransactionsA Turk buys an IBM server and pays with A Turk buys an IBM server and pays with

Turkish lira.Turkish lira.With the financial meltdown (2/01), IBM does With the financial meltdown (2/01), IBM does

not want to hold Turkish lira.not want to hold Turkish lira. IBM takes the TL to Turkish Central Bank and IBM takes the TL to Turkish Central Bank and

gets USD.gets USD. In the Turkish BOP, the official reserve In the Turkish BOP, the official reserve

account shows a reduction of foreign assets account shows a reduction of foreign assets (+).(+).

In the US BOP, foreign ownership of US In the US BOP, foreign ownership of US assets has fallen (-).assets has fallen (-).

4343

http://www.economist.com/agenda/displaystory.cfm?story_id=3834261&fsrc=nwl

4444

US Balance of Payments Accounts, US Balance of Payments Accounts, 2003 in Billions of Dollars2003 in Billions of Dollars

4545

US Balance of Payments Accounts, US Balance of Payments Accounts, 2003 in Billions of Dollars2003 in Billions of Dollars

4646

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.

4747

http://www.bea.gov/international/bp_web/simple.cfm?anon=71&table_id=1&area_id=3

4848

2004 2005 2006

4949

2004 2005 2006

5050

5151

2004 2005 2006

5252

5353

5454

5555

5656

US Balance of Payments AccountsUS Balance of Payments Accounts

The US has the most negative net foreign wealth The US has the most negative net foreign wealth in the world, and so is therefore the world’s in the world, and so is therefore the world’s largest debtor nation.largest debtor nation.

Its current account deficit in 2004 was $670 Its current account deficit in 2004 was $670 billion dollars, so that net foreign wealth billion dollars, so that net foreign wealth continued to decrease.continued to decrease.

The value of foreign assets held by the The value of foreign assets held by the US has grown since 1980, but liabilities of US has grown since 1980, but liabilities of the US (debt held by foreigners) has grown more the US (debt held by foreigners) has grown more quickly.quickly.

5757


5858


About 70% of foreign assets held by the US are About 70% of foreign assets held by the US are denominated in foreign currencies and almost all of US denominated in foreign currencies and almost all of US liabilities (debt) are denominated in dollars.liabilities (debt) are denominated in dollars.

Changes in the exchange rate influence value of net Changes in the exchange rate influence value of net foreign wealth (gross foreign assets minus gross foreign foreign wealth (gross foreign assets minus gross foreign liabilities).liabilities). A depreciation of the US dollar makes foreign assets held by the A depreciation of the US dollar makes foreign assets held by the

US more valuable, but does not change the dollar value of dollar US more valuable, but does not change the dollar value of dollar denominated debt.denominated debt.

5959

http://www.bea.gov/bea/di/intinv05_t3.xls

6060

6161

6262

http://www.economist.com/markets/PrinterFriendly.cfm?Story_ID=3868486

6363

6464http://www.bea.gov/newsreleases/international/intinv/2008/pdf/intinv07.pdf

6565

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.

http://www.economist.com/blogs/certainideasofeurope/2008/02/how_america_and_europe_own_eac.cfm

6666

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)."

Documents

1 Ch. 12: National Income Accounting and the Balance of Payments