Transcript National Income Accounting and the Balance of Payments

Ch. 13: National Income Accounting
and the Balance of Payments
Udayan Roy
ECO41 International Economics
International Macroeconomics
• International Trade studies the effects of
globalization on how the resources of a
country are allocated among different
productive activities
• International Macroeconomics studies the
effects of globalization on how the aggregate
spending of a country is allocated among
different types of spending
International Macroeconomics
• International macroeconomics introduces four
aspects of economic life that are ignored in
international trade:
– Unemployment
– Saving
– Trade imbalances
– Money and the price level
International Macroeconomics
• International macroeconomics tries to explain
the behavior—across countries at any given
time, or across time for a given country—of
economic variables that are ignored in
international trade
• These variables are measured by the tools of
– National income accounting, and
– Balance of payments accounting
THE NATIONAL INCOME ACCOUNTS
The National Income Accounts
• A country’s gross national product (GNP) is
the value of all final goods and services
produced by the country’s factors of
production and sold on the market in a given
time period
The National Income Accounts
• A country’s gross national product (GNP) is
the value of all final goods and services
produced by the country’s factors of
production and sold on the market in a given
time period
– Factors of production are the resources used in
production (such as labor, capital, and natural
resources)
The National Income Accounts
• A country’s gross national product (GNP) is
the value of all final goods and services
produced by the country’s factors of
production and sold on the market in a given
time period
– Final goods and services are goods and services
that have been or will be sold to their final users
– These goods will not be used to produce other
goods for sale
The National Income Accounts
• A country’s gross national product (GNP) is
the value of all final goods and services
produced by the country’s factors of
production and sold on the market in a given
time period
– Why are only final goods counted? Why are
intermediate goods not counted?
– To avoid counting the same productive activity
multiple times
The National Income Accounts
• A country’s gross national product (GNP) is
the value of all final goods and services
produced by the country’s factors of
production and sold on the market in a given
time period
– Why are only final goods counted?
– We need to measure national income. It is the
expenditure of the buyers of final goods and
services that trickles down into people’s pockets
The National Income Accounts
• The value of the production of all final goods
and services (GNP)
= value of total expenditure on those goods
and services
= income earned by the factors of production
• So, there are three equivalent approaches to
GNP measurement: production, expenditure,
and income
The National Income Accounts
• Of the production, expenditure and income
approaches to GNP measurement, the
expenditure approach is the most useful in
international macroeconomic theory
The National Income Accounts
• Government economists and statisticians divide
total expenditure (GNP) into four types of
expenditure:
– consumption (expenditure by private domestic
residents),
– investment (expenditure by private firms to build new
plant and equipment for future production),
– government purchases (expenditure by the
government), and
– the current account (net exports of goods and
services)
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From GNP to National Income
• National Income = GNP – Depreciation + Net
Unilateral Transfers
• Depreciation is the economic loss due to the
wearing out of machinery and structures as
they are used
• Gross National Product – Depreciation = Net
National Product
From GNP to National Income
• National Income = GNP – Depreciation + Net
Unilateral Transfers
• Unilateral transfers are payments made
without getting something in return
• Net Unilateral Transfers = Unilateral Transfers
received from foreigners – Unilateral Transfers
paid to foreigners
From GNP to National Income
• National Income = GNP – Depreciation + Net
Unilateral Transfers
• Examples of unilateral transfers are pension
payments to retired citizens living abroad,
reparation payments, and foreign aid. For the
United States in 2012, the balance of such
payments amounted to around –$129.7
billion, representing a 0.8 percent of GNP net
transfer to foreigners.
From GNP to GDP
• GNP = GDP + net receipts of factor income
from the rest of the world.
• Gross Domestic Product (GDP) is the market
value of all final goods and services produced
within the country’s borders
– Recall that GNP is the value of all final goods and
services produced by the country’s factors of
production anywhere in the world
From GNP to GDP
• GNP = GDP + net receipts of factor income
from the rest of the world.
• For the United States, net receipts of factor
income are primarily the income residents of
the US earn on wealth they hold in other
countries less the payments residents of the
US make to foreign owners of wealth located
in the US.
From GNP to GDP
• GNP = GDP + net receipts of factor income
from the rest of the world.
• As a practical matter, movements in GDP and
GNP usually do not differ greatly.
– GNP tracks national income more closely than
GDP does, and national welfare depends more
directly on national income than on GDP.
– See next slide
GDP: https://fred.stlouisfed.org/series/GDPCA; GNP: https://fred.stlouisfed.org/series/GNPCA
National Income Identity for an Open
Economy
• We will denote GNP by the symbol Y.
• We have seen before that government
statisticians break down total expenditure
(GNP) into four categories of expenditure:
– Consumption (C)
– Investment (I)
– Government Purchases (G)
– Current Account (CA) = Exports (EX) – Imports (IM)
• Y = C + I + G + EX – IM
National Income Identity for an Open
Economy
• Y = C + I + G + EX – IM
• An economy goes into a recession and suffers
high unemployment when total expenditure
(GNP or Y) is too low
• In such a situation, we need to use this
equation and figure out policies that can raise
C or I or G or EX – IM
CA and International Borrowing
• CA = EX – IM
• When EX > IM, CA > 0. The country has a
current account surplus
• When EX < IM, CA < 0. The country has a
current account deficit
CA Surplus = International Lending
• CA = EX – IM
• When EX > IM, CA > 0. The country has a
current account surplus
• This requires domestic residents to lend the
amount of the current account balance (CA) to
foreign residents
– Suppose there are only two countries, Anne and Bob.
Anne’s exports to Bob equal $100 and Anne’s imports from
Bob equal $75. This is possible only if Bob borrows $25
from Anne.
CA Deficit = International Borrowing
• CA = EX – IM
• When EX < IM, CA < 0. The country has a
current account deficit
• This requires domestic residents to borrow
the amount of the current account balance
(CA) from foreign residents
– Suppose there are only two countries, Anne and Bob.
Anne’s exports to Bob equal $100 and Anne’s imports from
Bob equal $125. This is possible only if Anne borrows $25
from Bob.
International Lending/Borrowing =
International Asset Purchases/Sales
• Borrowing money is the same as selling a
financial asset
– When a corporation borrows money it does so by
selling corporate bonds, which are financial assets
• Lending money is the same as buying a
financial asset
– When you buy US Treasury bonds, you are lending
money to the US government
Net Foreign Wealth
• Net Foreign Wealth of a country = Value of
domestic residents’ assets that were bought
from foreign residents – Value of foreign
residents’ assets that were bought from
domestic residents
CA > 0 means Net Foreign Wealth↑
• CA = EX – IM. So, when EX > IM, CA > 0 and
the country has a current account surplus.
• We saw that this requires domestic residents
to lend the amount of the current account
balance (CA) to foreign residents
• This lending is the same as domestic residents
buying assets from foreign residents
• Therefore, the country’s net foreign wealth
increases by the amount equal to CA
CA < 0 means Net Foreign Wealth↓
• CA = EX – IM. So, when EX < IM, CA < 0 and
the country has a current account deficit.
• We saw that this requires domestic residents
to borrow the amount of the current account
balance (CA) from foreign residents
• This borrowing is the same as domestic
residents selling assets to foreign residents
• Therefore, the country’s net foreign wealth
decreases by the amount equal to CA
CA and International Borrowing
• Therefore, the current account balance is a
rough measure of the increase in net foreign
wealth
– So a string of current account deficits (surpluses)
can lead to a dramatic decrease (increase) in a
country’s net foreign wealth
• Net Foreign Wealth is also called Net
International Investment Position
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CA: https://fred.stlouisfed.org/series/BPBLTT01USA637S.
IIP: https://fred.stlouisfed.org/series/IIPUSNETIA.
Expenditure and Production in an Open Economy
Y = C + I + G +CA
CA = 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
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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
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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
payments
Y – T is total after-tax
Private Saving: Public Saving: income or disposable
Sp = Y – T – C
Sg = T – G
income
National Saving = Private Saving + Public Saving
S = Sp + Sg
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S = Sp + Sg
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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
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S = S p + Sg
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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.
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CA = S – I
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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.
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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.
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BALANCE OF PAYMENTS ACCOUNTS
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Balance of Payments Accounts
• A country’s balance of payments accounts summarizes
all economic transactions between domestic residents
and foreign residents.
• Each international transaction enters the accounts
twice:
– once as a credit, and
– once as a debit
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Credits and Debits
• A country’s balance of payments accounts
keep track of both its payments to and its
receipts from foreigners.
• Any transaction resulting in a receipt from
foreigners is entered in the balance of
payments accounts as a credit.
• Any transaction resulting in a payment to
foreigners is entered as a debit.
Credits: examples
• Sale of goods, services, and assets to foreign
residents
• Receipt of income from assets bought from
foreign residents
– Dividends received on foreign firms’ shares,
interest paid on bonds sold by foreign firms and
governments, rent received on foreign real estate
• Unilateral transfers received from foreign
residents
Debits: examples
• Purchase of goods, services, and assets from
foreign residents
• Payment of income for domestic assets sold to
foreign residents
– Dividends paid on domestic firms’ shares, interest
paid on bonds sold by domestic firms and
government, rent paid on domestic real estate
• Unilateral transfers given to foreign residents
The Boomerang Principle
• Why does each cross-border transaction
appear twice in the balance of payments
accounts, once as a credit and again as a
debit?
• Suppose you pay a foreigner in dollars (debit)
• Those dollars will one way or the other return
to the US (credit), because nobody uses
dollars in the foreign country
The Boomerang Principle
• Suppose you pay Johan in Berlin in dollars for
some purchase (debit)
• Johan uses euros, not dollars
• So he may deposit the dollars in a US bank, as
savings for his future
• Or, he may sell the dollars—in return for
euros—to, say, Heidi, who wants dollars to
buy something from some American
• Either way, the dollars you paid Johan will
return to the US (credit)
Balance of Payments Accounts (cont.)
• The balance of payment accounts are separated into 3
broad accounts:
– current account: purchases and sales of goods and services
(imports and exports).
– financial account: purchases and sales of financial assets
(cross-border borrowing and lending).
– capital account: transfers of special categories of assets
(capital), typically non-market, non-produced, or intangible
assets like debt forgiveness, copyrights and trademarks.
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Example of Balance of
Payment Accounting
• You buy a fax machine from the Italian company Olivetti and
pay with a $1,000 check.
• Olivetti deposits the funds in its bank account in Citibank, New
York. Olivetti considers the money in its bank account a
financial asset worth $1,000 that it has just bought.
Credits
$1,000
Fax machine purchase
(Current account, US import of a good)
Sale of bank deposit by Citibank
(Financial account, US sale of an asset)
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Debits
$1,000
Example of Balance of
Payment Accounting
• You buy lunch in France and pay by credit card.
• French restaurant receives payment from your credit card
company
Credits
Meal purchase
(current account, U.S. service import)
Sale of credit card claim
(financial account, U.S. asset sale)
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Debits
$200
$200
Example of Balance of
Payment Accounting
• You buy a share of BP, a British firm.
• BP deposits the money in a U.S. bank.
Credits
Stock purchase
(financial account, U.S. asset purchase)
Bank deposit
(financial account, U.S. asset sale)
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Debits
$95
$95
Example of Balance of
Payment Accounting
• U.S. banks forgive a $5,000 debt owed by the government of
Bygonia through debt restructuring.
• U.S. banks who hold the debt thereby reduce the debt by
crediting Bygonia’s bank accounts.
Credits
Debt forgiveness
(capital account, U.S. transfer payment)
Reduction in bank’s claims (financial
account, U.S. asset sale)
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Debits
$5,000
$5,000
Total Credits = Total Debits
• We saw earlier that for every transaction that
is recorded in the balance of payments
accounts as a credit there is another
transaction of equal value that is recorded as
a debit
• Therefore, Total Credits = Total Debits
Total Credits = Total Debits
• Total Credits = Total Debits
• Credits in Current Account + Credits in Capital
Account + Credits in Financial Account =
Debits in Current Account + Debits in Capital
Account + Debits in Financial Account
• (Credits in Current Account – Debits in Current
Account) + (Credits in Capital Account – Debits
in Capital Account) = Debits in Financial
Account – Credits in Financial Account
“Balance”
• For the Current Account and the Capital
Account,
– Balance = Total Credits – Total Debits
• But for the Financial Account,
– Balance = Total Debits – Total Credits
= Lending – Borrowing
= Net Lending
= Financial outflows – financial inflows
= Net Financial Flows
Fundamental Balance of Payments
Identity
• (Credits in Current Account – Debits in Current
Account) + (Credits in Capital Account – Debits
in Capital Account) = (Debits in Financial
Account – Credits in Financial Account)
• Current Account Balance + Capital Account
Balance = Financial Account Balance
– Recall that the financial account balance is also
called net financial flows or net lending
Fundamental Balance of Payments
Identity
• Anne and Bob are the only two countries
• Anne exports $100 of goods and services to
Bob.
• In return Bob exports $75 of goods and
The capital
services to Anne plus $25 of financial assets.
account has no
role in this
• Anne’s current account balance = +$25 example.
that the
• Anne’s financial account balance = +$25 Note
balances must
be the same in
• Bob’s current account balance = –$25
each country.
• Bob’s financial account balance = –$25
Fundamental Balance of Payments
Identity
• Note that Anne’s (Bob’s) net foreign wealth
increases by the amount of Anne’s (Bob’s)
current account balance
• That is, the current account balance is the
increase in a nation’s net foreign wealth (or,
International Investment Position)
– We will see later that a nation’s IIP can change for
other reasons as well
Current Account Balance
• Current Account Balance = Credits – Debits
• Current Account Credits
– Exports of goods
– Exports of services
• E.g., Payment received for legal work, tourists’ spending
– Income receipts (primary income)
• E.g., interest and dividends received, profits received
from businesses located abroad but owned by domestic
residents
– Unilateral transfers (gifts) received
Current Account Balance
• Current Account Balance = Credits – Debits
• Current Account Debits
– imports of goods
– imports of services
– Income payments (primary income)
– Unilateral transfers (gifts) given
• Roughly speaking, a nation’s current account
balance equals its net exports of goods and
services
NUT = gifts
received – gifts
given. Gifts given
exceeded gifts
received by
$129.7 billion
Credits – Debits
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Income is made up mostly
of international interest
and dividend payments
and the earnings of
domestically owned firms
operating abroad.
A negative current account
is called a deficit: $440.4
billion has to be made up
by borrowing.
NUT = gifts
received – gifts
given. Gifts given
exceeded gifts
received by
$129.7 billion
Credits – Debits
Income is made up mostly
of international interest
and dividend payments
and the earnings of
domestically owned firms
operating abroad.
A negative current account
is called a deficit: $440.4
billion has to be made up
by borrowing.
This is credits – debits. It is
a positive amount, which
indicates that $7.0 billion
was received.
But that still leaves $433.4
to be borrowed.
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Financial Account Balance
• Financial account balance = net purchases of foreign assets by
domestic residents – net purchases of domestic assets by
foreign residents
= lending – borrowing = net lending
= outflow – inflow = net financial flows
• Financial inflow (borrowing)
– When foreign residents give loans to domestic residents, they
acquire/purchase financial assets from domestic residents
– These financial inflows are credits in the financial account
– They represent an increase in the indebtedness of domestic residents
• Financial outflow (lending)
– When domestic residents give loans to foreign residents, they
acquire/purchase financial assets from foreign residents
– These financial inflows are debits in the financial account
– They represent an increase in the wealth of domestic residents
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Balance of Payments Accounts (cont.)
• Roughly speaking, a nation’s net financial flows
equals the increase in its net foreign wealth
– In 2012, US net financial flows was -$439.4 billion.
As a negative increase amounts to a decrease, this
means US net foreign wealth actually decreased in
2012
– Net foreign wealth is also called International
Investment Position
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Net Errors and Omissions
• In theory, Current Account Balance + Capital
Account Balance = Financial Account Balance
• In reality, the two sides don’t match, because
of imperfections in the data
• This mismatch is called Net Errors and
Omissions or Statistical Discrepancy
• Statistically, Current Account Balance + Capital
Account Balance + Net Errors and Omissions =
Financial Account Balance
Official Reserve Transactions
• 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
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Official Settlements Balance
• Official Settlements Balance
= net purchase of international reserves by
domestic central bank – net purchase of
domestic assets by foreign central banks
= net lending to foreign residents by domestic
central bank – net lending to domestic
residents by foreign central banks
= net lending to foreign residents through
interventions by central banks
Official Settlements Balance
• Roughly speaking:
– Net financial flows is the net new lending by
domestic residents to foreign residents
• This was -$439.4 billion in 2012
– Official settlements balance is the net new lending
by domestic residents to foreign residents through
transactions that involve central banks
• This was -$389.4 billion in 2012
• This is also called net central bank financial flows
Income is made up mostly
of international interest
and dividend payments
and the earnings of
domestically owned firms
operating abroad.
A current account deficit:
$440.4 billion has to be
made up by borrowing.
This is a positive amount,
which indicates that $7.0
billion was received. That
still leaves $433.4 to be
borrowed.
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The net US acquisition of financial
assets = acquisition of new assets
from foreign residents – the sale
(back to foreign residents) of
assets US residents had bought
from foreign residents in the past.
So, this is new US lending to
foreigners.
New US borrowing from
foreigners
US net borrowing from
foreigners. Should have
been $433.4 billion.
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Measurement is imperfect. It
seems we borrowed $6 billion
more than what the theory
implies.
All central banks combined gave US
residents a loan of $389.4 billion.
So a huge chunk of the $439.4
billion that US residents borrowed
to pay for their current account
deficit was from foreign central
banks. This is not a good sign
because it suggests that privatesector lenders would not provide
the loans needed to support the
US’s current account deficit.
This is the new lending to
foreigners by the US central bank,
the Fed
This is US residents’ new
borrowing from foreign central
banks.
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US residents’ net asset purchases
involving central banks is 4.5 –
393.9 = – $389.4 billion. This is the
official settlements balance of the
US. Informally, this too is called
balance of payments.
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 continues to be in deficit.
– So, its net foreign wealth continues 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.
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Changes in Net Foreign Wealth (IIP)
• We have seen that a country’s net foreign
wealth increases by the amount of its net
financial flows
• But net foreign wealth can change for two
other reasons as well
Changes in Net Foreign Wealth (IIP)
• Changes in the market price of wealth
previously acquired can alter a country’s net
foreign wealth.
– When Japan’s stock market lost three-quarters of
its value over the 1990s, for example, American
and European owners of Japanese shares saw the
value of their claims on Japan plummet, and
Japan’s net foreign wealth increased as a result.
Changes in Net Foreign Wealth (IIP)
• Exchange rate changes have a similar effect.
When the dollar depreciates against foreign
currencies, for example, foreigners who hold
dollar assets see their wealth fall when
measured in their home currencies.
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Recall from Table 13-2 that this was the
US current account deficit in 2012.
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These reflect changes in the dollar values of assets bought
(sold) by US residents from (to) foreign residents caused
by asset price changes and exchange rate changes.
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12-82
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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.
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Any Questions?
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