Chapter 5: National and International Accounts

Goals: Understanding how to measure macroeconomic activity in an open economy.

In a closed economy we have three equivalent measurements for macroeconomic activity.

(I) Gross national expenditure (GNE) = personal consumption (C) + investment (I) + Government spending (G). GNE is an expenditure measure.

(II) Gross domestic product (GDP) = value of all intermediate and final goods and services produced within a country’s territorial borders, minus the values of all goods and services purchased as inputs. GDP is an output measure.

(III) Gross national income (GNI) = total income resources of the economy. GNI is an income measure.

In closed economy GNE = GDP because the nation’s expenditure must be spent on the final goods and services it produces; GDP = GNI because GDP measures the value of firm outputs minus the cost of firm inputs, and the remaining flow is paid by firms as income to factors, such as the owners of labor, capital and land employed by firms.

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In an open economy those three measures are not necessarily equal.

In an open economy, because of trade in goods and services, not all of the GNE payments go to GDP, and not all of GDP payments arise from GNE.

GDP = GNE + Export (EX) – Import (IM)

Trade Balance (TB) by definition equals EX minus IM

So GDP = GNE + TB

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In an open economy, because of trade in factor services (FS), not all of the GDP incomes go to GNI, and not all of GNI incomes arise from GDP.

Denote the income from overseas by EXFS, and the income going overseas by IMFS

EXFS - IMFS is called net factor income from abroad (NFIA).

GNI = GDP + NFIA

Exercise: GNI = GNE + ___________________

In the past GNI was called GNP, or gross national product.

Read the application on page 165 to see sometimes GNI is a better measurement than GDP of economic performance.

Many international transactions, such as foreign air and income remittance, take place outside of markets.

Gross national disposable income (GNDI) = GNI + NUT

where NUT denotes the net unilateral transfers. For countries receiving big foreign aid, NUT can be substantial.

The current account (CA) by definition = TB + NFIA + NUT.

GNDI (Y) = GNE + CA

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Note we use letter Y as shorthand for GNDI.

GNDI is full income measure.GNE measures payments by home entities.CA measures net payments to home arising from the full range of international transactions and transfers.

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CA can tell us whether a nation is spending more or less than its income. To see this, we start with the open-economy national income identity, which is in effect the definition for GNDI:

Y = C + I + G + CA (5-5)

if CA > 0, Y _________ C + I + G

if CA < 0, Y _________ C + I + G

National income is greater than expenditure if and only if CA is positive, or in surplus. National income is less than expenditure if and only if CA is negative, or in deficit.

Subtracting C + G from both sides of (5-5), and defining the national saving as S = Y – G – I, then we end up with the current account identity:

S = I + CA (5-6)6

CA > 0 if S______I

CA < 0 if S______I

(5-6) tells us that to reduce a current account deficit, a country must increase its national saving or reduce domestic investment.

Discuss how higher US barriers to imports from China would affect its national saving, domestic investment, and current account deficit. If restriction on imports from China does not work, how to reduce US current account deficit?

Note: National saving = personal saving (Sp = Y– T - C) + public saving (Sg =T - G) where T denotes taxes.

We can rewrite (5-6) as

CA = Sp + Sg – I (5-10)

Using (5-10) discuss whether a fiscal deficit (negative Sg) must cause a current account deficit.

5-3 The balance of payments (BOP)

BOP provides a detailed picture of the composition and financing of the current account. All transaction between a country and the rest of world are recorded in BOP accounts.

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The financial account (FA) records transactions that involve financial assets. The total value of the financial assets that are received by the rest of world (ROW) from the home country is the home country’s export of assets, denoted by EXA. The total value of financial assets that are received by the home country from ROW is the home country’s import of assets (IMA)

FA = EXA - IMA

The capital account (KA) records the acquisition and disposal of nonfinancial and nonproduced assets, and capital transfers. For US, KA is negligible. Assets issued by home entities are home assets; assets issued by foreign entities are foreign assets.

When a home country holds a foreign asset, it is called external asset because it represents an obligation owed to the home country by ROW.

Conversely, from home country’s perspective, a home asset is a claim on the home country. When a foreign entity holds such an asset, it is called external liability, because it represents an obligation owed by the home country to ROW.

GNE + CA + FA + KA = GNE

where GNE + CA represents resources available to home country due to income, and FA + KA represents resources available to home country due to trade in assets.

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We can cancel GNE from both sides, and end up with the balance of payments identity:

CA + FA + KA = 0 (5-12)

(5-12) implies that any current account deficit must be matched by an equal surplus in the other two accounts.

You need to refer to double-entry bookkeeping in accounting class to fully understand (5-12).See side bar on page 182 for examples of double-entry bookkeeping.

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