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Chapter 13 National Income Accounting and the Balance of Payments November 2011

Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Page 1: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Chapter 13

National Income Accounting and the Balance of Payments

November 2011

Page 2: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-2

From Trade to Finance, From Microeconomics to Macroeconomics: What’s New?

• Unemployment

• Saving

• Trade imbalances

• Money and the price level

Page 3: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-3

What’s in this chapter?

• National income accounts

National saving, investment and the current account

• Balance of payments accounts

Page 4: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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National Income Accounts

• A country’s national income accounts record how income is earned and spent.

Producers earn income by selling their goods and services to buyers.

Buyers spend what they earn from production.

The amount of expenditure by buyers = the income earned by sellers = the value of production.

National income is the total income earned by a nation’s factors of production.

Page 5: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Factors of Production

• What are factors of production?

labor (workers),

physical capital (like factories and equipment),

natural resources, and

other

Page 6: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-6

National Income Accounts: GDP

• Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given time period. This is the expenditure definition of GDP; there are others Intermediate goods are goods that are used in the production of

other for-sale goods. • They disappear inside other goods, as grapes disappear inside wine, or

milk inside ice cream, or flour inside bread

All other goods are called final goods. • These are goods sold to their final users, rather than to producers of other

for-sale goods

Intermediate goods are not counted separately. • The market value of a final good already includes the value of the

intermediate goods used in its production.

• GDP counts only final goods in order to avoid counting intermediate goods more than once

Page 7: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-7

National Income Accounts: GDP

• GDP = total value added by producers located in the country This is the production definition of GDP Value added (by a producer) = market value of goods and services

produced – market value of goods and services bought from other producers

• GDP = total income generated by domestic production This is the income definition of GDP Gross domestic income (GDI) is the name given to GDP when

calculated by statisticians using the income definition In theory GDP = GDI. But in practice the numbers usually differ. This difference is called

statistical discrepancy.• GDP = GDI + statistical discrepancy

Page 8: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-8

National Income Accounts: GNP

• Gross national product (GNP) is the total income earned by the resources owned by the legal residents of a country in a given time period.

• GNP = GDP + income earned from foreign residents – income paid to foreign residents

• GNP = GDP + net income from foreign residents (NIF) Gross national income: GNI = GDI + NIF = GNP, in

theory GNP = GNI + statistical discrepancy, in practice

Page 9: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-9

National Income Accounts: Components of GDP

• GDP is the market value of expenditure on all final goods and services produced within the country.

• This expenditure consists of 4 categories :1. Consumption (C): expenditure by domestic residents

2. Investment (I): expenditure by firms on plants & equipment

3. Government purchases (G): expenditure by governments on goods and services

4. Net exports = exports – imports

– NX = EX – IM

– net expenditure by foreigners on domestic goods and services

• GDP = C + I + G + EX – IM = C + I + G + NX

• GNP = C + I + G + NX + NIF

Page 10: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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GDP = Expenditure on final goods and services produced domestically

GDP = Cd + Id + Gd + EX

= (C – Cf) + (I – If) + (G – Gf) + EX

= C + I + G + EX – (Cf + If +Gf)

= C + I + G + EX – IM

= C + I + G + NX

Domestic expenditure

Net expenditureby foreigners

Cd is consumption spending on domestic goods.

Cf is consumption spending on foreign goods.

Page 12: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Gross National Disposable Income

• Gross National Disposable Income (GNDI) is the total disposable income of a country’s residents

• GNDI = GNI + gifts received from foreign residents – gifts given to foreign residents

• NUT = gifts received from foreign residents – gifts given to foreign residents is called net unilateral transfers

• GNDI = C + I + G + NX + NIF + NUT• CA = NX + NIF + NUT is called the current account

balance• GNDI = C + I + G + CA

GNDI is denoted by the symbol Y.

• Y = C + I + G + CA

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Page 13: Chapter 13 National Income Accounting and the Balance of Payments November 2011

GDP, GNP, GNDI: Recap

• GNDI is denoted Y• Y = GNP + NUT

= GDP + NIF + NUT= C + I + G + NX + NIF + NUT= C + I + G + CA

• In practice, net income from foreign residents (NIF) and net unilateral transfers from foreign residents (NUT) are usually very small in magnitude

• Therefore, GNDI, GNP and GDP are usually very similar in magnitude

• Therefore, often they will all be denoted by the symbol Y.

12-13

Page 14: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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National Income Accounts

• GNP is not the only measure of a nation’s income: National Income and GDP are two other measures.

• Net National Product = GNP – Depreciation • Depreciation of capital is the wear and tear of capital. This results

in a loss of income to capital owners. So the amount of depreciation is subtracted from GNP.

• National Income = NNP – statistical discrepancy In theory, NNP and national income are the same NNP is measured using the expenditure approach and

national income (or Net National Income, NNI) is measured using the income approach, but they both measure the same thing

The different measuring techniques lead to the statistical discrepancy

Page 15: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Expenditure and Production in an Open Economy

Y = C + I + G +CACA = Y – (C + I + G )

• When domestic production (Y) > domestic expenditure (C+I+G), current account = trade balance > 0, exports > imports when a country exports more than it imports, it earns more income

from exports than it spends on imports. So, net foreign wealth increases

• When domestic production < domestic expenditure, exports < imports, current account = trade balance < 0 when a country exports less than it imports, it earns less income

from exports than it spends on imports. So, net foreign wealth decreases

Page 16: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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US Current Account As a Percentage of 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

Page 17: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-18

US Current Account, 1960–2004

-700

-600

-500

-400

-300

-200

-100

0

100

1960 1965 1970 1975 1980 1985 1990 1995 2000

year

bill

ions

of

curr

ent

doll

ars

Source: Bureau of Economic Analysis, US Department of Commerce

Page 18: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Net Foreign Wealth

• US Net Foreign Wealth = foreign assets owned by US residents – US assets owned by foreign residents

• The change in net foreign wealth during a year depends on the current account balance for that year Changes in worldwide asset prices Changes in exchange rates (that are used to

convert wealth measured in various currencies into a common currency)

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Page 19: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Net Foreign Wealth in U.S.

12-20

Page 20: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Fig. 12-2: U.S. Current Account and Net Foreign Wealth, 1976–2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007 release

US Net Foreign Wealth = foreign assets owned by US residents – US assets owned by foreign residents

Page 21: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Saving and the Current Account

• National saving (S) = national income (Y) that is not spent on consumption (C) or on government purchases (G).

• S = Y – C – G

Page 22: Chapter 13 National Income Accounting and the Balance of Payments November 2011

National Saving = Private Saving + Public Saving

S = Y – C – G S = Y – C – G – T + T S = Y – T – C + T – G

The government’s net tax revenues are denoted T. T = tax revenues – transfer paymentsY – T is total after-tax income or disposable income

Private Saving:Sp = Y – T – C

Public Saving:Sg = T – G

National Saving = Private Saving + Public SavingS = Sp + Sg

Page 23: Chapter 13 National Income Accounting and the Balance of Payments November 2011

S = Sp + Sg

Page 24: Chapter 13 National Income Accounting and the Balance of Payments November 2011

The Meaning of Saving and Investment

• Budget Surplus and Budget Deficit If T > G, the government runs a budget surplus

because it receives more money than it spends.• T – G represents public saving.

If G > T, the government runs a budget deficit because it spends more money than it receives in tax revenue.

• Fun fact: In the 2010 fiscal year, the US federal government ran a budget deficit of $1.3 trillion

Page 25: Chapter 13 National Income Accounting and the Balance of Payments November 2011

S = Sp + Sg

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Page 26: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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How Is the Current Account Related to National Saving?

Y = C + I + G + CA

Y – C – I – G = CA

CA = (Y – C – G ) – I

= S – I

current account = national saving – investment

current account = net foreign investment

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

Page 27: Chapter 13 National Income Accounting and the Balance of Payments November 2011

CA = S – I

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Page 28: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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How Is the Current Account Related to National Saving? (cont.)

CA = S – I or I = S – CA

• Countries can pay for investment either by using domestic saving or by borrowing foreign funds equal to the current account deficit.

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

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

Page 29: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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How Is the Current Account Related to National Saving? (cont.)

CA = Sp + Sg – I

= Sp – government deficit – I

• Government deficit is negative government saving equal to G – T

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

Page 30: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Inverse Relationship Between Public Saving and Current Account?

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

Page 31: Chapter 13 National Income Accounting and the Balance of Payments November 2011

BALANCE OF PAYMENTS ACCOUNTS

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Page 32: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts

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

• Each international transaction enters the accounts twice:

once as a credit (+) and

once as a debit (-).

Page 33: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts (cont.)

• 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.

Page 34: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Example of Balance of Payment Accounting

• 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(current account)

–$30

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

+$30

Page 35: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Example of Balance of Payment Accounting (cont.)

• 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 (financial account)

–$500

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

+$500

Page 36: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Example of Balance of Payment Accounting (cont.)

• 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(capital account)

–$100 M

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

+$100 M

Page 37: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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“Balance”

• Balance = total credits – total debits When understood to be a numerical value,

• current account stands for balance of the current account,

• capital account stands for balance of the capital account, and

• financial account stands for balance of the financial account.

Page 38: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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How Do the Balance of Payments Accounts Balance?

• Due to the double entry of each transaction, the overall balance must be zero:

current account +

financial account +

capital account = 0

• For U.S. data, see this Web site of the Bureau of Economic Analysis, U.S. Department of Commerce

Page 39: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Balance of Payments Accounts

• Current account balance = (exports of goods and services – imports of goods and services) + (factor income received from foreigners – factor income paid to foreigners) + (gifts of current income received from foreigners – gifts of current income paid to foreigners)

• CA = NX + NIF + NUTincome

12-41

Page 40: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts (cont.)

• Financial account = sales of domestic assets to foreigners – purchases of foreign assets by domestic citizens.

• Financial inflow Foreign citizens give loans to domestic citizens by acquiring

domestic assets. (+) Foreigners’ purchase of assets from domestic citizens are a credit

(+)

• Financial (capital) outflow Domestic citizens give loans to foreigners by acquiring their assets

(foreign assets). (-) Domestic citizens’ purchase of assets from foreign citizens are a

debit (-)

Page 41: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Balance of Payments Accounts (cont.)

• Financial account balance = capital inflow – capital outflow =borrowing from foreign residents – lending to foreign residents

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Page 42: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts (cont.)

• Financial account has at least 3 categories:

1. Official (international) reserve assets

2. All other assets

3. Statistical discrepancy

Page 43: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts (cont.)

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

accounts at the International Monetary Fund.

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

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

Page 44: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts (cont.)

• Statistical discrepancy

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

The balance of payments 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 current account and capital account.

Page 45: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Balance of Payments Accounts (cont.)

• The negative of the balance of 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.

Page 46: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Official Settlements Balance

• If the official settlements balance is a negative number, the balance of the official reserve transactions account must be a positive number.

• In this case the transactions of non-central bank entities has increased our debt.

• And so, either foreign central banks must help us out by buying our assets or our central bank must sell its holdings of foreign assets.

• Thus, a crisis may be in the offing.12-49

Balance sSettlement OfficialBNRFAAccount CapitalAccountCurrent

Payments) of Balance (or, Balance sSettlement OfficialBORTA-

BORTA -BNRFAAccount CapitalAccountCurrent

0BORTABNRFAAccount CapitalAccountCurrent

Account nsTransactio Reserve Official of BalanceAccount Financial Reserve-Non of Balance Account Financial

0Account FinancialAccount CapitalAccountCurrent

Page 47: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-50

Balance of Payments Accounts (cont.)

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

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

Page 48: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Table 12-2: U.S. Balance of Payments Accounts for 2006 (billions of dollars)

Page 49: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Table 12-2: U.S. Balance of Payments Accounts for 2006 (billions of dollars)

Balance of Official Reserve Transactions = 2.4 + 440.3 = + 442.7

Official Settlements Balance = - 442.7.

Also called, Balance of Payments.

Page 50: Chapter 13 National Income Accounting and the Balance of Payments November 2011

12-53

US Balance of Payments Accounts

• The US has the highest negative net foreign wealth in the world, and is therefore the world’s biggest debtor nation.

• And its current account deficit in 2006 was $812 billion dollars. So, its net foreign wealth continued to decrease.

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

Page 51: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Table 12-3: International Investment Position of the United States at Year End, 2005 and 2006 (millions of dollars)

Page 52: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Table 12-3: International Investment Position of the United States at Year End, 2005 and 2006 (millions of dollars)

Page 53: Chapter 13 National Income Accounting and the Balance of Payments November 2011

Fig. 12-3: U.S. Gross Foreign Assets and Liabilities, 1976-2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007

Page 54: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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US Balance of Payments Accounts (cont.)

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

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

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

Page 55: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Summary

1. A country’s GNP is roughly equal to the income received by its factors of production.

2. In an open economy, GNP equals the sum of consumption, investment, government purchases, and the current account.

3. GDP is equal to GNP minus net receipts of factor income from abroad. It measures the output produced within a country’s borders.

Page 56: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Summary (cont.)

4. National saving minus domestic investment equals the current account (≈ exports minus imports).

5. The current account equals the country’s net foreign investment (net outflows of financial assets).

6. The balance of payments accounts records flows of goods & services and flows of financial assets across countries.

It has 3 parts: current account, capital account and financial account, which balance each other.

Transactions of goods and services appear in the current account; transactions of financial assets appear in the financial account.

Page 57: Chapter 13 National Income Accounting and the Balance of Payments November 2011

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Summary (cont.)

7. Official international reserve assets are a component of the financial account which records official assets held by central banks.

8. The official settlements balance is the negative value of official international reserve assets, and it shows a central bank’s holdings of foreign assets relative to foreign central banks’ holdings of domestic assets.

9. The US is the largest debtor nation, and its foreign debt continues to grow because its current account continues to be negative.