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)
12-14
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.
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 and International Borrowing
• 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 and 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.
CA and International Borrowing
• CA = EX – IM
• Net Foreign Wealth of a country = Value of
assets bought by domestic residents from
foreign residents – Value of assets bought by
foreign residents from domestic residents
CA and International Borrowing
• CA = EX – IM
• 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
CA and International Borrowing
• 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 and International Borrowing
• 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 =
change 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
12-31
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
12-32
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
12-33
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
13-34
S = Sp + Sg
13-35
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
13-36
S = S p + Sg
12-37
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.
12-38
CA = S – I
12-39
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.
12-40
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.
12-41
Inverse Relationship Between
Public Saving and Current Account?
US current account and public saving relative to GDP,
1960-2004
Percent of GDP
4%
2%
0%
-2%
-4%
-6%
-8%
1960
1965
1970
1975
1980
current account
1985
1990
1995
2000
public saving
Source: Congressional Budget Office, US Department of Commerce
12-42
BALANCE OF PAYMENTS ACCOUNTS
12-43
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 (-).
12-44
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
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.
12-48
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.
–$30
DVD purchase
(current account)
Credit (“sale”) of bank account by bank
(financial account)
12-49
+$30
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.
–$500
Purchase of stock
(financial account)
Credit (“sale”) of bank account by bank
(financial account)
12-50
+$500
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
–$100 M
(capital account)
Credit (“sale”) of bank account by bank
(financial account)
12-51
+$100 M
“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.
12-52
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
• This is called the Fundamental Balance of
Payments Identity
12-53
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
services to Anne plus $25 of financial assets.
The capital
• Anne’s current account balance = +$25 account has no
role in this
• Anne’s financial account balance = –$25 example.
Note that the
• Bob’s current account balance = –$25
balances must
sum to zero for
• Bob’s financial account balance = +$25 each country.
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 a
measure of the change in a nation’s net
foreign wealth (or, IIP)
– We will see later, however, that IIP can change for
other reasons as well
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 (-)
12-59
Balance of Payments Accounts (cont.)
• Financial account balance =
capital inflow – capital outflow =
sale of financial assets by domestic residents to
foreign residents – purchase of financial assets
by domestic residents from foreign residents =
net export of financial assets
12-60
Balance of Payments Accounts (cont.)
•
Financial account has at least
3 categories:
1. Official (international) reserve assets
2. All other assets
3. Statistical discrepancy
12-61
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 (-).
12-62
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.
12-63
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.
12-64
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.
12-67
US lending to foreigners
US borrowing from
foreigners
US net borrowing from
foreigners. Should have
been $433.4 billion.
12-68
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 borrowing
that US residents needed to pay for
their current account deficit was
from foreign central banks. This is
not a good sign because it suggests
that private-sector lenders would
not provide the loans needed to
support the US’s current account
deficit.
This is the lending to
foreigners (asset purchases) by
US central bank, the Fed
This is US residents’ borrowing
from (asset sales to) foreign
central banks.
12-69
US residents’ net asset purchases 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.
12-70
Changes in Net Foreign Wealth (IIP)
• We have seen that a country’s net foreign
wealth increases by the amount of its current
account balance
• 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.
12-74
Recall from Table 13-2 that this was the
US current account deficit in 2012.
12-75
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.
12-76
12-77
12-78
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.
12-79