Chapter 13 National Income Accounting and The Balance of Payments

Chapter 13
National Income Accounting

and
the Balance of Payments
Lectureon3/2/2016
Overview
The scope of the course:
Exchange rates and open-economy macroeconomics:
Economic openness: international transactions in goods
and services as well as financial assets.
microeconomics: from the perspective of individual firms
and consumers.
macroeconomics: how economies overall levels of
employment, production, and growth are determined.
Macroeconomics
Unemployment
Saving
Trade imbalances
Money and the price level
Preview
Two essential tools to capture a complete picture of the
macroeconomic linkages among economies that engage in
international trade:
National income accounting
Balance of payments accounting
National income accounting: records all the expenditures

that contribute to a countrys income and output.
measures of national income
measures of value of production
measures of value of expenditure
Copyright 2009 Pearson Addison-Wesley. All rights reserved.
13-4
Preview
Balance of payments accounts:
records both changes in a countrys indebtedness to
foreigners and the fortunes of its export- and importcompeting industries.
show the connection between foreign transactions and
national money supplies.
National Income Accounts

Records the value of national income that results from
production and expenditure.
Producers earn income from buyers who spend money on
goods and services.
The amount of expenditure by buyers =
the amount of income for sellers =
the value of production.
National income is often defined to be the income earned in
a period by a nations factors of production.
13-6
National Income Accounts: GNP

Gross national product (GNP) is the value of all final
goods and services produced by a nations factors of
production and sold on the market in a given time period.
What are factors of production? Factors that are used to
produce goods and services: workers (labor services),
physical capital (like buildings and equipment), natural
resources and others.
Therefore, GNP is closely linked to the employment of labor,
capital, and other factors of production.
The value of final goods and services produced by US-owned
factors of production are counted as US GNP.
13-7
National Income Accounts: GNP (cont.)
GNP is calculated by adding up the market value of all

expenditures on final goods and services produced.
There are 4 types of expenditure:

1. Consumption: the amount consumed by private domestic
residents.
2. Investment: the amount put aside by private firms to build
new plant and equipment for future production.
3. Government purchases: expenditure by governments on
goods and services
4. Current account balance (exports minus imports): the
amount of net exports of goods and services to foreigners.
13-8
Fig. 13-1: U.S. GNP and Its Components
Source:U.S.DepartmentofCommerce,BureauofEconomicAnalysis
13-9
GNP = Expenditure on a Countrys

Goods and Services
National
income =
value of
domestic
production
Y = 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 + CA
Expenditure by domestic
individuals and institutions
Expenditure
on domestic
production
Net expenditure by foreign

individuals and institutions
13-10
GNP (cont.)
The share of the domestic spending in the GNP:
1. Consumption: 62%~70% over the past 60 years.
2. Investment: 11% ~ 22% in recent years.
3. Government purchases: about 20%.
National Income Accounts: GNP vs. GDP

Gross domestic product (GDP): measures the volume of
production within a countrys borders ~ the final value of all
goods and services that are produced within a country in a
given time period.
does not correct for the portion of countries production carried
out using services provided by foreign-owned capital.
GDP = GNP net receipts of factor income from the rest of

the world (the income domestic residents earn on wealth they
hold in other countries the payments domestic residents
make to foreign owners of wealth that is located in the
domestic country)
12-12
GNP vs. GDP

As a practical matter , movements in GDP and GNP usually
do not differ greatly.
This book focuses on GNP because GNP tracks national
income more closely than GDP does, and national welfare
depends more directly on national income than on domestic
product.
National Income Accounts: GNP vs.

national income
GNP and national income are essentially equal

But, two adjustments to the GNP must be made for the
identification of GNP and national income:
1. Depreciation of physical capital: reduces the income of
capital owners, so the amount of depreciation is subtracted
from GNP.
2. Unilateral transfers: gifts to and from other countries:
foreign aid, reparation payments, and pension payments
sent to expatriate retirees.
.Net national product (NNP) = GNP-depreciation
.National income = GNPdepreciation+unilateral transfers
13-14
Expenditure and Production in an Open

Economy
CA = EX IM = Y (C + I + G )
= the change in the net foreign wealth
= intertemporal lending/borrowing
Exports > imports
current account surplus
the production > domestic expenditure
(when a country exports more than it imports, it earns more income
from
exports than it spends on imports)
net foreign wealth is increasing

(lend to its trade partners to finance their deficit)
13-15
Expenditure and Production in an Open

Economy(cont.)
CA = EX IM = Y (C + I + G )
= the change in the net foreign wealth
Exports < imports current account deficit
the production < domestic expenditure
(when a country exports less than it imports, it earns less income from
exports than it spends on imports)
net foreign wealth is decreasing
(borrow to finance the deficit)
Example: the largest debtor in the world: US ~ borrowed a sum

equal to more than 6% of its GNP in 2007.
13-16
Fig. 13-2: U.S. Current Account and Net

Foreign Wealth, 19762009
Source:U.S.DepartmentofCommerce,BureauofEconomicAnalysis,June2007release
13-17
Saving and the Current Account

National saving (S) = national income (Y) that is not spent
on consumption (C) or government purchases (G)
= (Y C T) + (T G)
= private saving + government saving (budget surplus)
= S p + Sg = S
In a closed economy:
Y=C + I + G
S = Y C G =I
13-18
How Is the Current Account Related to

National Saving?
In an open economy:
CA = Y (C + I + G )
implies
CA = (Y C G ) I
= S I
current account = national saving investment
current account = net foreign investment
It is possible simultaneously to raise investment and
foreign borrowing without changing saving in an open
economy.
13-19

National Saving? (cont.)
CA = S I
or
I = S CA
Countries can finance investment either by saving or by

acquiring foreign funds equal to the current account deficit.
a current account deficit implies a financial asset inflow or
negative net foreign investment.
When S > I, then CA > 0 so that net foreign investment and

financial capital outflows for the domestic economy are
positive.
13-20

National Saving? (cont.)
Sp = I + CA Sg
A countrys private saving can take three forms: investment
in domestic capital (I), purchases of wealth from foreigners
(CA), and purchases of the domestic governments newly
issued debt (G T)
CA = Sp + Sg I
A high government deficit causes a negative current
account balance when other factors remain constant.
However, government deficit reduction may not increase
the current account surplus. (case study on p.334)
13-21
Balance of Payments Accounts

A countrys balance of payments accounts for its payments
to and its receipts from foreigners.
An international transaction involves two parties, and each
transaction enters the accounts twice: once as a credit (+)
and once as a debit (-).
13-22
Balance of Payments Accounts (cont.)

The balance of payments accounts are composed of three
types of international transactions:
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, non-financial
and possibly intangible assets
ex. debt forgiveness, copyrights and trademarks.
13-23
Example of Balance of Payments Accounting

You import a fax machine from Olivetti.
Olivetti deposits your check in a U.S. bank.
credit
debit
Faxmachine
$80
(currentaccount,U.S.goodimport)
Bankdeposit
(financialaccount,U.S.assetsale)
$80
13-24

(cont.)
You buy lunch in France and pay by credit card.
French restaurant receives payment from your credit card
company.
credit
debit
Mealpurchase
$30
(currentaccount,U.S.serviceimport)
Saleofcreditcardclaim
(financialaccount,U.S.assetsale)
$30
13-24

(cont.)
You buy a share of BP.
BP deposits the money in a U.S. bank.
credit
debit
Purchase of stock
(financial account)
Credit (sale) of deposit in account by bank

(financial account)
$90
$90
13-26

(cont.)
U.S. banks forgive a $50 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.
credit
debit
Debt forgiveness: non-market transfer

(capital account)
Credit (sale) of account by bank

(financial account)
$50M
$50M
13-27
How Do the Balance of Payments Accounts

Balance?
Due to the double entry of each transaction, the balance of
payments accounts will balance by the following equation:
current account + financial account + capital account = 0
13-28
Balance of Payments Accounts

The 3 broad accounts are more finely divided:
Current account: imports and exports

1. goods (goods like DVDs, fax machine)
2. services (payments for legal services, shipping services,
tourist meals,)
3. income receipts (interest and dividend payments, earnings
of domestically owned firms and workers operating in
foreign countries)
Current account includes the net unilateral transfers

gifts (transfers) across countries that do not correspond to
the purchase of any good or service nor serve as income for
goods and services produced
13-29

Capital account: records special transfers of assets, but
this is a minor account for the U.S.
13-30

Financial account: the difference between sales of
domestic assets to foreigners and purchases of foreign
assets by domestic citizens.
Financial inflow (sometimes also called capital inflow)
Foreigners loan to domestic citizens by buying domestic
assets
Domestic assets sold to foreigners are a credit (+) because the
domestic economy acquires money during the transaction
13-31

Financial outflow (sometimes also called capital outflow)
Domestic citizens loan to foreigners by buying foreign assets
Foreign assets purchased by domestic citizens are a debit (-)
because the domestic economy gives up money during the
transaction
The financial account of the US includes:

1.
US assets held abroad, excluding financial derivatives
2.
Foreign assets held in US, excluding financial derivatives
3.
Net financial derivatives
13-32

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.
Merchandise trade data are relatively reliable, but data on
services are not.
13-33

Official (international) 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.
13-34

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.
13-35

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 international 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.
13-36
Table 13-2: U.S. Balance of Payments

Accounts for 2009 (billions of dollars)
13-37
Table 13-2: U.S. Balance of Payments

Accounts for 2009 (billions of dollars, cont.)
13-38
U.S. Balance of Payments Accounts

The U.S. has the most negative net foreign wealth in the
world, and so is therefore the worlds largest debtor nation.
And its current account deficit in 2009 was $378 billion
dollars, so that net foreign wealth continued 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 more quickly.
13-39
Fig. 13-3: U.S. Gross Foreign Assets and

Liabilities, 1976-2009
Source:U.S.DepartmentofCommerce,BureauofEconomicAnalysis,June2010.
13-40
U.S. Balance of Payments Accounts (cont.)

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.
13-41
GDP vs. GNP in Taiwan

GDP and GNP
600,000
500,000
400,000
300,000
200,000
100,000
GDP
GNP
Balance of Payments - Taiwan
2012
2013
2014
A. Current Account1.................................................................
48,947 55,257 65,335
Goods: exports f.o.b..............................................................
299,054 303,230 311,554

269,138 267,778 270,066
Goods: imports f.o.b.............................................................

Balance on Goods..............................................................
29,916 35,452 41,488
Services: credit........................................................................
49,078 51,284 57,372
Services: debit........................................................................
-42,727 -42,720 -46,208
Balance on Goods and Services.................................................................
36,267 44,016 52,652
Income: credit........................................................................
25,833 25,352 30,413
Income: debit........................................................................
-10,533 -11,115 -14,941
Balance on Goods, Services, and Income........................................................................

Current transfers: credit........................................................................
Current transfers: debit........................................................................
B. Capital Account1........................................................................
51,567 58,253 68,124

5,445
6,153
6,578
-8,065 -9,149 -9,367

-83
-76
Capital account: credit........................................................................
103
29
Capital account: debit........................................................................
-87
-97
-105
Total, Groups A plus B........................................................................
48,864 55,263 65,259
Balance of Payments Taiwan (cont.)
2012
C. Financial Account1........................................................................
Direct investment abroad........................................................................
Direct investment in R.O.C. (Taiwan)..............................................................
Portfolio investment assets........................................................................
2013
2014
-31,673 -42,934 -53,046

-13,137 -14,285 -12,597
3,207
3,598
2,839
-45,304 -36,814 -57,105
Equity securities........................................................................
-16,960
Debt securities........................................................................
-28,344 -29,202 -34,840
Portfolio investment liabilities........................................................................

Equity securities........................................................................
Debt securities........................................................................
Financial derivatives.....................................................................
Financial derivatives assets.....................................................................
Financial derivatives liabilities.....................................................................
Other investment assets........................................................................
Monetary authorities........................................................................
General
government................................................................................................................................................
-7,612 -22,265
3,213
7,980 12,895
2,906
9,618 13,756
307
-1,638
-861
328
770
283
4,526
5,851
5,689
-4,198
-5,081
-5,406
4,746 -49,534 -14,614

.
-1
Banks.................................................................................
-4,453 -60,256 -36,439
Other sectors........................................................................
9,196 10,723 21,817
Balance of Payments Taiwan (cont.)
2012
Other investment liabilities........................................................................
2013
2014
15,274 45,351 15,253
Monetary authorities........................................................................
General government........................................................................
10,575 41,391
9,638
Banks.................................................................................
Other sectors........................................................................
Total, Groups A through C........................................................................
D. Net Errors and Omissions........................................................................
4,699
3,958
5,613
17,191 12,329 12,213

-1,707 -1,011
802
Total, Groups A through D........................................................................
15,484 11,318 13,015
E. Reserves and Related Items........................................................................
-15,484 -11,318 -13,015
Reserve assets2........................................................................
-15,484 -11,318 -13,015
Use of Fund credit and loans........................................................................
Exceptional financing........................................................................
Summary
1.
A countrys 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 income from foreign

countries for factors of production. It measures the value
of output produced within a countrys borders.
13-46
Summary (cont.)
4.
National saving minus domestic investment equals the

current account ( exports minus imports).
5.
The current account equals the countrys 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.
13-47
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
banks holdings of foreign assets relative to foreign
central banks holdings of domestic assets.
9.
The U.S. is the largest debtor nation, and its foreign debt
continues to grow because its current account continues
to be negative.
13-48
AdditionalChapterArt
13-49
Table 13-1: National Income Accounts for Agraria, an

Open Economy (bushels of wheat)
13-50
Table 13-3: International Investment Position of the

United States at Year End, 2005 and 2006 (millions
of dollars)
13-51

Chapter 13 National Income Accounting and The Balance of Payments

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Chapter 13

National Income Accounting

National income accounting

Balance of payments accounting

National income accounting: records all the expenditures

National Income Accounts

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

National Income Accounts: GNP

National Income Accounts: GNP (cont.)

GNP is calculated by adding up the market value of all

There are 4 types of expenditure:

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Fig. 13-1: U.S. GNP and Its Components

GNP = Expenditure on a Countrys

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Net expenditure by foreign

National Income Accounts: GNP vs. GDP

GDP = GNP net receipts of factor income from the rest of

GNP vs. GDP

National Income Accounts: GNP vs.

GNP and national income are essentially equal

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Expenditure and Production in an Open

net foreign wealth is increasing

Expenditure and Production in an Open

net foreign wealth is decreasing

(borrow to finance the deficit)

Example: the largest debtor in the world: US ~ borrowed a sum

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Fig. 13-2: U.S. Current Account and Net

Saving and the Current Account

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

How Is the Current Account Related to

How Is the Current Account Related to

Countries can finance investment either by saving or by

When S > I, then CA > 0 so that net foreign investment and

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

How Is the Current Account Related to

Balance of Payments Accounts

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Balance of Payments Accounts (cont.)

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Example of Balance of Payments Accounting

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Example of Balance of Payments Accounting

Example of Balance of Payments Accounting

Credit (sale) of deposit in account by bank

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Example of Balance of Payments Accounting

Debt forgiveness: non-market transfer

Credit (sale) of account by bank

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

How Do the Balance of Payments Accounts

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Balance of Payments Accounts

Current account: imports and exports

Current account includes the net unilateral transfers

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Balance of Payments Accounts (cont.)

Copyright 2012 Pearson Addison-Wesley. All rights reserved.

Balance of Payments Accounts (cont.)

Copyright 2012 Pearson Addison-Wesley. All rights reserved.