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International Finance
M1 MCI
Christelle Sapata
2017-2018
christelle.sapata-carpantier@u-pec.fr
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Part 1. Exchanges rates and openeconomy macroeconomics
Chapter
2.
National
income
accounting and the balance of
payments
National income accounting and the
balance of payments
§ The first step in studying international finance is to understand the
accounting concepts that economists use to describe a country’s
level of production and its international transactions.
1. National income accounting (records all the expenditures that
contribute to a country’s output/income);
2. Balance of payment accounting (helps us keep track of both
changes in a country’s indebtedness to foreigners and its net
exports + shows the connection between foreign transactions
and national money supplies).
§ These are 2 related tools that allow you to get a complete picture of
the macroeconomic linkages among economies that engage in
international trade.
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National product accounting and the
balance of payments
2.1.
Domestic income accounts
2.1.1. Gross Domestic Product
2.1.2. Gross National Product
2.2.
Domestic income accounting for an open economy
2.3.
The balance of payments accounts
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Gross Domestic Product
§ Gross Domestic Product = GDP = value of all final goods and
services produced within a country and sold on the market in a
given period of time.
§ It includes value of goods like bread sold in a supermarket,
textbooks sold in a bookstore, value of services provided by
plumbers, etc.
§ It is the basic measure of a country’s output used by
macroeconomists.
§ We divide GDP among the four uses for which a country’s final
output is purchased:
Y = C + I + G + (X – M)
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Gross Domestic Product
§ Gross Domestic Product = GDP = value of all final goods and
services produced within a country and sold on the market in a
given period of time.
§ It includes value of goods like bread sold in a supermarket,
textbooks sold in a bookstore, value of services provided by
plumbers, etc.
§ It is the basic measure of a country’s output used by
macroeconomists.
§ We divide GDP among the four uses for which a country’s final
output is purchased:
Y= C + I + G + (X – M)
Amount consumed by private domestic residents
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Gross Domestic Product
§ Gross Domestic Product = GDP = value of all final goods and
services produced within a country and sold on the market in a
given period of time.
§ It includes value of goods like bread sold in a supermarket,
textbooks sold in a bookstore, value of services provided by
plumbers, etc.
§ It is the basic measure of a country’s output used by
macroeconomists.
§ We divide GDP among the four uses for which a country’s final
output is purchased:
Y = C + I + G + (X – M)
Amount put aside by private firms to build new plant
and equipment for future production
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Gross Domestic Product
§ Gross Domestic Product = GDP = value of all final goods and
services produced within a country and sold on the market in a
given period of time.
§ It includes value of goods like bread sold in a supermarket,
textbooks sold in a bookstore, value of services provided by
plumbers, etc.
§ It is the basic measure of a country’s output used by
macroeconomists.
§ We divide GDP among the four uses for which a country’s final
output is purchased:
Y= C + I + G + (X – M)
Amount used by the government
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Gross Domestic Product
§ Gross Domestic Product = GDP = value of all final goods and
services produced within a country and sold on the market in a
given period of time.
§ It includes value of goods like bread sold in a supermarket,
textbooks sold in a bookstore, value of services provided by
plumbers, etc.
§ It is the basic measure of a country’s output used by
macroeconomists.
§ We divide GDP among the four uses for which a country’s final
output is purchased:
Y= C + I + G + (X – M)
Amount of net exports of goods and services to foreigners
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Gross Domestic Product
§ Gross Domestic Product = GDP = value of all final goods and
services produced within a country and sold on the market in a
given period of time.
§ It includes value of goods like bread sold in a supermarket,
textbooks sold in a bookstore, value of services provided by
plumbers, etc.
§ It is the basic measure of a country’s output used by
macroeconomists.
§ We divide GDP among the four uses for which a country’s final
output is purchased:
Y= C + I + G + (X – M)
This structure is essential to understand the cause of a particular
recession or boom.
Gross Domestic Product and Domestic
Income
Domestic Income = GDP
– Depreciation + Net Unilateral Transfers
Pension payments to retired citizens
Economic loss due to the tendency of
machinery and structures to wear out as living abroad, Foreign Aid, Etc.
they are used
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Domestic product and domestic income
Domestic Income ≈ GDP
For simplicity reasons, the domestic income is commonly
considered as equal to the GDP…
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National income accounting and the
balance of payments
2.1.
2.2.
2.3.
National income accounts
2.1.1. Gross Domestic Product
2.1.2. Gross National Product
National income accounting for an open economy
The balance of payments accounts
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Gross National Product
§ The U.S used to report Gross National Product (GNP) rather than
GDP as their primary measure of national economic activity.
§ In 1991, the U.S. began to report GDP.
§ GNP and GDP both reflect the national output of an economy, but:
§ GDP (Gross Domestic Product) is a measure of national output
produced in a particular country.
§ GNP includes the value of the output produced by nationals
whether in the country or not.
§ GNP = GDP + Net property income from abroad. This net income
from abroad includes dividends, interest and profit.
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Gross National Product
§ Question:
A. If a Japanese multinational produces cars in the UK. This
production will be counted towards UK GDP, or UK GNP?
B. If a UK firm makes profit from insurance companies located abroad,
and this profit is sent back to UK nationals, is this amount part of
UK GDP or UK GNP, or both?
C. If a Japanese firm invests in the UK (new factory), will the UK GDP
increase more or less than the UK GNP?
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Gross Domestic Product
Example:
A.If a Japanese multinational produces cars in the UK. This production
will be counted towards UK GDP. However, if the Japanese firm sends
£50m in profits back to shareholders in Japan, then this outflow of profit
is subtracted from GNP. UK nationals don’t benefit from this profit.
B.If a UK firm makes profit from insurance companies located abroad,
then if this profit is sent back to UK nationals, then this net income from
oversees assets will be added to UK GNP.
C.Note if a Japanese firm invests in the UK, it will still lead to higher
GNP, as some national workers will see higher wages. However, the
increase in GNP will not be as great as GDP.
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GDP
GNP
Stands for
Gross Domestic Product
Gross National Product
Definition
An estimated value of the
total worth of a country’s
production and services,
within its boundary, by its
nationals and foreigners,
calculated over the course of
one year.
An estimated value of the
total worth of production and
services, by citizens of a
country, on its land or on
foreign land, calculated over
the course of one year.
Formula
GDP = consumption +
investment + (government
spending) + (exports −
imports)
GNP = GDP + NR (Net
income inflow from assets
abroad or Net Income
Receipts) - NP (Net payment
outflow to foreign assets)
Application
To see the strength of a
country’s local economy
To see how the nationals of a
country are doing
economically
Country with highest per
capita (in US$)
Luxembourg ($120,000)
Switzerland ($80,560)
Country with lowest per
capital (in US$)
South Soudan ($246)
Burundi ($290)
Country with highest (total)
USA ($20.83 Trillion in 2018)
USA (~$18.6 Trillion in 2018)
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Stands for
GDP
GNP
Gross Domestic Product
Gross National Product
Definition
An estimated value of the
total worth of a country’s
production and services,
within its boundary, by its
nationals and foreigners,
calculated over the course of
GNP=GDP if NR=0 and NP=0
one year.
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An estimated value of the
total worth of production and
services, by citizens of a
country, on its land or on
foreign land, calculated over
the course of one year.
Formula
GDP = consumption +
investment + (government
spending) + (exports −
imports)
GNP = GDP + NR (Net
income inflow from assets
abroad or Net Income
Receipts) - NP (Net payment
outflow to foreign assets)
Application
To see the strength of a
country’s local economy
To see how the nationals of a
country are doing
economically
Country with highest per
capita (in US$)
Qatar ($102,943)
Luxembourg ($45,360)
Country with lowest per
capita (in US$)
Liberia ($16)
Mozambique ($80)
Country with highest (total)
USA ($13.06 Trillion in 2006)
USA (~ $11.5 Trillion in 2005)
National income accounting and the
balance of payments
2.1.
2.2.
National income accounts
2.1.1. Gross Domestic Product
2.1.2. Gross National Product
National income accounting for an open economy
2.2.1. The current account and foreign indebtedness
2.2.2. Saving and the current account
2.2.3. Private and government saving
2.3.
The balance of payments accounts
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National income accounting for an open
economy
§ The GDP for an open economy is:
Y=C+I+G+(X–M)
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The current account and foreign
indebtedness
§ Assuming that a country’s foreign trade can be exactly balanced is
non-sense (X=M)
§ The differences between export and imports of goods and services
is known as the current account balance (CA)*
CA = X – M
§ If X<M => current account deficit. The country must borrow the
difference from foreigners, the net debt increases.
§ If X>M => current account surplus. The country lends to its trading
partners.
§ CA= change in foreign wealth
§ CA = measure the change and direction of international borrowing
* Here, we neglect the income balance and net unilateral transfers of income
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The current account and foreign
indebtedness
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The current account and foreign
indebtedness
Source: IMF, Sector external report 2018
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The current account and foreign
indebtedness
Source: IMF, External sector report 2018
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Saving and the current account
§ Open economy : Y = C + I + G + (X-M)
§ Closed economy: Y = C + I + G
§ In a closed economy, saving, S, is the portion of the total output, Y,
that is not devoted to private consumption, C, or government
purchases, G.
§ Closed economy : S = Y – C – G
§ Closed economy : S = I
§ Opening the economy yields : S = I + CA
§ In a closed economy, investment can increase only through
increased saving. Or an increase in saving is equivalent to an
increase in domestic investment.
§ In an open economy, saving is associated to domestic investment
OR to change in net foreign wealth !
Remember: these are identities, there is no theoretical framework.
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Saving and the current account
§ Implication: it is possible simultaneously to raise investment and
foreign borrowing without changing saving!
Example:
§ New Zealand decides to build a new hydroelectric plant.
§ NZ imports the materials it needs from a European partner and
borrow European funds to pay for them.
Ø This transaction raises New Zealand’s domestic investment.
Ø The transaction also raises New Zealand’s current account
deficit.
§ New Zealand’s saving does not have to change, even though
investment rises.
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Private and government saving
•
•
Disposable income is national income Y less net taxes, T, collected
from households and firms by the government.
Private saving: part of the disposable income that is not consumed.
Sp = Y – T – C
•
Government saving : its net tax revenue, T, less its consumption, G.
Sg = T – G
§ National saving: sum of the private and public saving
S = Sp + Sg
•
We already know that in an open economy : S = I + CA
•
Hence, Sp
= S – Sg = I + CA – (T – G) = I + CA + (G – T)
Government budget deficit
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Private and government saving
Sp = I + CA + (G – T)
§A country’s private saving can take three forms:
1.Investment in domestic capital (I)
2.Purchase of wealth from foreigners (CA)
3.Purchases of the domestic government’s newly issued debt (G – T)
To to: Read case study 1 “ Government deficit reduction
may not increase the current account surplus”. An
illustration of the usefulness of this equation.
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National income accounting and the
balance of payments
2.1.
2.2.
2.3.
National income accounts
2.1.1. National product and national income
2.1.2. Gross Domestic Product
National income accounting for an open economy
2.2.1. The current account and foreign indebtedness
2.2.2. Saving and the current account
2.2.3. Private and government saving
The balance of payments accounts
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The balance of payments accounts
§ To understand foreign exchange markets, and foreign exchange
risks, you need to understand the economic forces that cause
exchange rate to fluctuate.
§ Exchange rate respond to demand and supply to trade currencies,
which arise from international trade flows, and international capital
flows.
§ Useful information is provided by the balance of payments =
records the payment between residents of one country and the rest
of the world.
§ Three types of international transactions are recorded in the balance
of payments:
1. Transactions that arise from export or import of goods and
services and therefore enter directly into the current account.
2. Transactions that arise from the purchase or sale of financial
assets.
3. Certain other activities resulting in transfers of wealth between
countries are recorded in the capital account.
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The balance of payments accounts
1. Transactions that arise from export or import of goods and
services and therefore enter directly into the current account.
Ø Rule: Any transactions that involves a flow of funds into home
country is a credit item (plus sign). Any transaction that involves a
flow of funds out of home country (Brazil, US) is a debit (minus
sign).
Ex: when a French consumer imports American blue jeans, the
transaction enters the U.S. balance of payments accounts as a credit
on the US current account.
Question: How will be registered in the US balance of payment the
following transactions?
•
•
Imports of Huawei phones from China
Exports of ipods to France
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The balance of payments accounts
2. Transactions that arise from the purchase or sale of financial
assets go into the financial account. An asset is any one of
the forms in which wealth can be held, such as money, stocks,
factories, or government debt. The financial account of the
balance of payments records all international purchases or
sales of financial assets.
§ Example 1: When an American company buys a French factory, the
transaction enters the U.S. balance of payments as a debit in the US
financial account. It enters as a debit because the transaction
requires a payment from the U.S. to France.
§ Example 2: A U.S. sale of assets to foreigners enters the U.S.
financial account as a credit, because it requires a payment to the
US.
§ The difference between a country’s purchases (debit) and sales
(credit) of foreign assets = financial account balance or net
financial flows.
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The balance of payments accounts
3.
Certain other activities resulting in transfers of wealth between
countries are recorded in the capital account.
§ These international asset movements are minor. They encompass
unilateral transfers of assets between countries, such as debt
forgiveness or migrant ́s transfers (the assets that migrants take with
them when they move into or out of a country). It measures the net
flow of assets unilaterally transferred into the country.
§ Keep in mind the following rule of double-entry bookkeeping:
Every international transaction automatically enters the balance of
payments twice, once as a credit and once as a debit because if
you buy something from a foreigner, you must pay him in some way,
and the foreigner must then somehow spend or store your payment.
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Examples of paired transactions
Example:
§ Imagine a US citizen buys an ink-jet fax machine from the Italian
company Olivetti and pay for your purchase with a $1,000 check.
§ This payment to buy the fax machine from a foreign resident enters
the U.S. current account as a debit.
§ But where is the off-setting balance of payments credit?
§ Olivetti’s U.S. salesperson must do something with your check (let’s
say he deposits it in Olivetti’s account at Citibank in New York).
§ In this case, Olivetti has purchased , and Citibank has sold, a U.S.
asset (a bank deposit worth $1,000) and the transaction shows up
as a $1,000 credit in the U.S. financial account.
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Examples of paired transactions
Example 2:
§ Suppose that a US citizen pays $200 for a dinner at the Restaurant
de l’Escargot d’Or in France.
§ Lacking cash, he places the charge on his Visa credit card.
§ This is a tourist expenditure, will be counted as a service import for
the U.S., and therefore as a current account debit.
§ Where is the offsetting credit?
§ Your signature on the Visa slip entitles the restaurant to receive
$200 (actually, its euros equivalent) from First Card, the company
that issued your Visa card.
§ It is therefore an asset, a claim on a future payment from First Card.
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The fundamental balance of payments
identity
§ Because any international transaction automatically gives rise to
offsetting credit and debit entries in the balance of payments, the
sum of the current account balance and the capital account
balances automatically equals the financial account balance.
Current account + Capital account = Financial Account
negligible
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Deficit of CA
= current payments
to foreigners exceed
current receipts
= U.S. residents
used
more output than
they
produced.
In total, the U.S.
need to
cover $378.5 billion!
Is it matched by an
equal
amount of net
liabilities
in its financial
account?
The fundamental balance of payments
identity
Current account + Capital account = Financial Account
§ When US borrows $1 from foreigners, it is selling them an asset, a
promise that the US will repay $1, in the future, with interest.
§ When the US lends abroad, it acquires assets, i.e., the right to claim
the repayment in the future.
§ To cover its current account deficit, the US needs to borrow the
same amount from foreigners (or sale assets to foreigners).
§ How come that financial account does not equal current account?
Ø Information from offsetting credit and debit items associated to a
given transaction can be collected from different sources of
information that may differ in accuracy, time, etc.
Ø Omissions, errors, etc.
§ Account keepers force the two sides to balance by
adding a NET ERROR AND OMMISSIONS ITEM.
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Official reserve transactions
§ One type of financial account transaction merit separate discussion,
namely the purchase or sale of official reserve assets by central
banks.
§ An economy’s central bank = the institution responsible for
managing the supply of money.
§ Official international reserves = foreign assets held by central
banks as a cushion against national economic misfortune.
§ Official reserves used to consist largely of gold, but also foreign
financial assets, treasury bills.
§ Central banks buy or sell international reserves in private asset
markets to affect macroeconomic conditions in their economies =
« official foreign exchange intervention ».
§ It is a way for the central bank to inject money into the economy or
withdraw it from circulation.
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Official reserve transactions
§ When a central bank purchases or sells a foreign asset, the
transaction appears in its country’s financial account (just as if it had
been a transaction by a private citizen).
§ A transaction in which the central bank of Japan acquires dollar
assets might occur as follows:
§ A U.S. auto dealer imports a Nissan sedan from Japan and pays the
auto company with a check for $20,000.
§ Nissan does not want to invest the money in dollar assets, but the
central bank of Japan is willing to give Nissan Japanese money in
exchange for the $20,000 check.
§ The Bank of Japan’s international reserves rise total Japanese
assets held in the U.S., the latter rise by $20,000.
§ This transaction results in a $20,000 credit in the U.S. financial
account, the other side of the $20,000 debit in the U.S. current
account due to the import of the car.
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Summary
§ International macroeconomics is concerned with the full employment
of scarce economic resources and price level stability throughout the
world economy.
§ The national income accounts and the balance of payments
accounts are essential tools for studying the macroeconomics of
open, interdependent economies, because they reflect national
expenditure patterns and their international repercussions.
§ The domestic income accounts divide domestic income according to
the types of spending that generate it: consumption, investment,
government purchases, and the current account balance.
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Summary
§ In an economy closed to international trade, GDP must be
consumed, invested, or purchased by the government.
§ By using current output to build plant, equipment, and inventories,
investment transforms present output into future output.
§ In an open economy, GNP equals the sum of consumption,
investment, government purchases, and net exports of goods and
services.
§ Trade does not have to be balanced if the economy’s can borrow
from and lend to the rest of the world.
§ The current account also equals the country’s net lending to
foreigners: national saving equals domestic investment plus the
current account balance.
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Summary
§ Balance of payments accounts provide a detailed picture of the
payments/transactions between residents of one country and the
rest of the world in a given period.
§ The accounts are based on the convention that any transaction
resulting in a payment to foreigners is entered as a debit while any
transaction resulting in a receipt from foreigners is entered as a
credit.
§ Transactions involving goods and services appear in the current
account of the balance of payments, while international sales and
purchases of assets appear in the financial account.
§ The capital account records mainly non-market asset transfers.
§ The sum of the current and capital account balances must equal the
financial account balance (net financial flows).
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Summary
§ International asset transactions carried out by central banks are
included in the financial account.
§ Any central bank transaction in private markets for foreign currency
assets is called « official foreign exchange intervention ».
§ One reason intervention is important is that central banks use it as a
way to change the amount of money in circulation.
§ A country has a deficit in its balance of payments when it is running
down its official international reserves or borrowing from foreign
central banks (it has surplus in the opposite case).
To do: Read Case Study 2 « The Assets and Liabilities of the World’s
Biggest Debtor ».
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