1

Section 1The Balance of Payments

2

Content

• Objectives

• The National Income Accounts

• S, I, and CA

• The BOP Accounts

• Bookkeeping

• Summary

3

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.

4

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.

5

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.

6

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

7

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

8

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.

9

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.

10

Figure 12-1: U.S. GNP and Its Components, 2000

11

Figure 12-2: The U.S. Current Account and Net Foreign Wealth Position, 1977-2000

12

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

13

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

14

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

15

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

16

S, I, and CA

• The current account is a measure of foreign savings at home.

• Are current account deficits good?

• The twin deficits hypothesis.

17

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 (-).

18

The BOP Accounts

• The Current Account (CA)– The current account divides exports and

imports into three categories:• Merchandise trade

• Services

• Interest and dividend income

19

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.

20

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.

21

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

22

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

23

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

24

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.

25

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.

26

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.