1 International Finance Chapter 5 National and International Income Accounting and the Balance of Payments

1

International Finance

Chapter 5

National and International Income Accounting

and

the Balance of Payments

2

Chapter Introduction

• So far, we have studied how exchange rates are determined in the short run and in the long run.

• As a macroeconomic variable, exchange rates directly affect international trade in goods and services as well as international investments and financial transactions.

• In this chapter, we first study the international accounting system of trade and payments. Next, we examine how international transactions relate to national income and wealth.

3

Chapter Outline

• National income accounts– GNE, GDP, GNI, & GNDI– Current account

• National saving, investment, and the current account

• Balance of payments accounts

4

National Income Accounts

• Gross National Expenditure

GNE = C + I +G• Expenditure approach gives

GDP = C + I + G + EX – IM• Trade Balance

TB = EX - IM– If TB > 0, exports > imports trade surplus– If TB < 0, exports < imports trade deficit

5


• Gross national income equals gross domestic product (GDP) plus net factor income from abroad (NFIA).

From GDP to GNI: Accounting for Trade in Factor Services

NFIAabroad from incomefactor Net

TBbalance Tradeeexpenditur national Gross

)()( FSFS

GDP

GNE

IMEXIMEXGICGNI

6

Ireland GDP vs. GNI

A Paper Tiger? The chart shows trends in GDP, GNI, and NFIA in Ireland from 1980 to 2011. Irish GNI per capita grew more slowly than GDP per capita during the boom years of the 1980s and 1990s because an ever-larger share of GDP was sent abroad as net factor income to foreign investors. Close to zero in 1980, this share had risen to around 15% of GDP by the year 2000 and has remained there.

7


If a country receives transfers worth UTIN and gives transfers worth UTOUT, then its net unilateral transfers (NUT), are

NUT = UTIN − UTOUT .

Adding net unilateral transfers to gross national income, gives a full measure of national income in an open economy, known as gross national disposable income (GNDI), henceforth Y:

From GNI to GNDI: Accounting for Transfers of Income

8

From GNI to GNDI: Accounting for Transfers of Income

Major Transfer Recipients The chart shows average figures for 2000 to 2010 for all countries in which net unilateral transfers exceeded 15% of GNI. Many of the countries shown were heavily reliant on foreign aid, including some of the poorest countries in the world, such as Liberia, Eritrea, Malawi, and Nepal. Some countries with higher incomes also have large transfers because of substantial migrant remittancesfrom a large number of emigrant workers overseas (e.g., Tonga, El Salvador, Honduras, and Cape Verde).

9


• On the left is our full income measure, GNDI.

• The first term on the right is GNE, which measures payments by home entities.

• The remaining terms measure net payments to the home country from all international transactions in goods, services, and income. We group the three cross-border terms into an umbrella term that is called the current account (CA).

What the National Economic Aggregates Tell Us

10


U.S. Economic Aggregates in 2012 The table shows the computation of GDP, GNI, and GNDI in 2012 in billions of dollars using the components of gross national expenditure, the trade balance, international income payments, and unilateral transfers.

11


U.S. Current Accounts and Its Components, 1990-2012 The figure shows the trade balance (TB), net factor income from abroad (NFIA), and net unilateral transfers (NUT) in billions of dollars.

12

National saving, investment, and the current account

• This equation is the open-economy national income identity. It tells us that the current account represents the difference between national income Y (or GNDI) and gross national expenditure GNE (or C + I + G). Hence:

• GNDI is greater than GNE if and only if CA is positive, or in surplus.

• GNDI is less than GNE if and only if CA is negative, or in deficit.

Y C I G CA

13


• Private saving (Sp) = Y – C – T • Public saving (Sg) = T – G • National saving (S) = Sp + Sg = Y – C – G • So, S = I + CA; CA = S – I

– If S > I, the excess saving will be invested in foreign assets (capital outflow);

– If S < I, the excess investment will have to be financed by foreign borrowing (capital inflow).

– CA = net foreign investment = net foreign wealth

14


The charts show saving (blue), investment (red), and the current account (beige) as a percent of GDP.

Global Imbalances

15


In the 1990s, emerging markets moved into current account surplus and thus financed the overall trend toward current account deficit of the industrial countries.Note: Oil producers include Norway.

Global Imbalances (continued)

16


This chart shows private saving and the chart on the next slide public saving, both as a percent of GDP. Private saving has been declining in the industrial countries, especially in Japan (since the 1970s) and in the United States (since the 1980s). Private saving has been more stable in the Euro area and other countries.

Private and Public Saving Trends: Industrial Countries

17


Public saving is clearly more volatile than private saving. Japan has been mostly in surplus and massively so in the late 1980s and early 1990s. The United States briefly ran a government surplus in the late 1990s but has now returned to a deficit position.

Private and Public Saving Trends: Industrial Countries (continued)

18

Twin Deficits

• CA = Sp – I – (G – T)– If Sp and I remain constant, a high government deficit

(G – T) generates a high current account deficit.– In reality, Sp and I probably won’t remain constant.

19

Balance of Payments

• BOP is a report of one country’s transactions with other countries.

• Double-entry bookkeeping: a transaction enters the accounts twice: a credit (+) and a debit (-)– A Payment received is reported as a credit;– A payment made is reported as a debit.

• Components of BOP– Current account: flows of goods, services, income, unilateral

transfers;– Financial account: real assets, financial assets, and official reserve

assets;– Capital account: non-market, non-produced, or intangible assets;

and statistical discrepancy.

20

Examples of BOP Double-Entry BK

• 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)

–$500

Credit (“sale”) of deposit in account by bank(financial account)

+$500

21

Examples (Cont.)

• GM exports $2 million worth of automobiles to China.

• China’s importer pays for the automobiles by writing a check with its Citi Bank account.

Automobile sales(current account)

+$2,000,000

Deduction of Chinese importer’s US$ account at Citi Bank

(financial account)

-$2,000,000

22

Examples (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)

–$100 M

Credit (“sale”) of account by bank (financial account)

+$100 M

23

Examples (Cont.)

• A private charity in the U.S. ships $50,000 worth of goods as aid following an hurricane that devastated the southeast region of Taiwan.

24

Examples (Cont.)

• A private charity in the U.S. ships $50,000 worth of goods as aid following an hurricane that devastated the southeast region of Taiwan.

Exports of goods from U.S.(current account)

$50,000

Unilateral transfer(financial account)

-$50,000

25

The Balance of BOP

• Due to double-entry book keeping, the BOP will balance as

Current account + Financial account + Capital account = 0

26

Balance of Payments

The table shows U.S. international transactions in 2012 in billions of dollars. Major categories are in bold type.

The U.S. Balance of Payments in 2012

27

Balance of Payments


The U.S. Balance of Payments in 2012 (continued)

28

Balance of Payments


The U.S. Balance of Payments in 2012 (continued)

29

Official Reserve Assets

• Official (foreign) reserve assets: foreign assets held by central banks to cushion against financial instability.– 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 (+) because the domestic central bank can spend more money to cushion against instability.

– Official reserve assets owned by (purchased by) the domestic central bank are a debit (-) because the domestic central bank can spend less money to cushion against instability.

30

Official Reserve Assets

• The negative value of the official reserve assets 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.

– A negative official settlements balance may indicate that a country • is depleting its official foreign reserve assets or • may be incurring large debts to foreign central banks so that

the domestic central bank can spend a lot to protect against financial instability.

31

Net Foreign Wealth• A country’s net foreign wealth

• A country’s net foreign wealth is also called its net international investment position. (Note that it is a stock measure, not a flow measure).

If W > 0, home is a net creditor country: external assets exceed external liabilities.

If W < 0, home is a net debtor country: external liabilities exceed external assets.

LA

W

world theofrest by

owned assets Home

homeby owned

assetsForeign =alth foreign weNet

32

Net Foreign Wealth

What External Wealth Tells Us

• External wealth data tell us the net credit or debit position of a country with respect to the rest of the world.

• They include data on external assets (foreign assets owned by the home country) and external liabilities (home assets owned by foreigners).

• A creditor country has positive external wealth, a debtor country has negative external wealth.

• Countries with a current account surplus (deficit) must be net buyers (sellers) of assets.

33

Net Foreign Wealth

What External Wealth Tells Us (Cont.)

• An increase in a country’s external wealth results from every net import of assets; conversely, a decrease in external wealth results from every net export of assets.

• In addition, countries can experience capital gains or losses on their external assets and liabilities that cause changes in external wealth.

• All of these changes are summarized in the statement of a country’s net international investment position.

34

Net Foreign Wealth

• The U.S. 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 2014 was $389.5 billion dollars, so net foreign wealth continues to decrease.

• 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 faster.

35

U.S. Gross Foreign Assets and Liabilities ($billions), 1976 - 2014

Source: U.S. Department of Commerce, Bureau of Economic Analysis,

36

Net Foreign Wealth

• 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 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.

Documents

1 International Finance Chapter 5 National and International Income Accounting and the Balance of Payments