Chapter 13
National Income
Accounting and
the Balance
of Payments
November 2011
From Trade to Finance, From
Microeconomics to Macroeconomics:
What’s New?
• Unemployment
• Saving
• Trade imbalances
• Money and the price level
12-2
What’s in this chapter?
• National income accounts

National saving, investment and the current account
• Balance of payments accounts
12-3
National Income Accounts
• A country’s national income accounts record how
income is earned and spent.

Producers earn income by selling their goods and
services to buyers.

Buyers spend what they earn from production.

The amount of expenditure by buyers =
the income earned by sellers =
the value of production.

National income is the total income earned by a
nation’s factors of production.
12-4
Factors of Production
• What are factors of production?
 labor
(workers),
 physical
 natural
capital (like factories and equipment),
resources, and
 other
12-5
National Income Accounts: GDP
• Gross domestic product (GDP) is the market value of all final
goods and services produced within a country in a given time
period.

This is the expenditure definition of GDP; there are others

Intermediate goods are goods that are used in the production of
other for-sale goods.
• They disappear inside other goods, as grapes disappear inside wine, or
milk inside ice cream, or flour inside bread

All other goods are called final goods.
• These are goods sold to their final users, rather than to producers of other
for-sale goods

Intermediate goods are not counted separately.
• The market value of a final good already includes the value of the
intermediate goods used in its production.
• GDP counts only final goods in order to avoid counting intermediate goods
more than once
12-6
National Income Accounts: GDP
• GDP = total value added by producers located in the country

This is the production definition of GDP

Value added (by a producer) = market value of goods and services
produced – market value of goods and services bought from other
producers
• GDP = total income generated by domestic production

This is the income definition of GDP

Gross domestic income (GDI) is the name given to GDP when
calculated by statisticians using the income definition

In theory GDP = GDI.

But in practice the numbers usually differ. This difference is called
statistical discrepancy.
• GDP = GDI + statistical discrepancy
12-7
National Income Accounts: GNP
• Gross national product (GNP) is the total
income earned by the resources owned by the
legal residents of a country in a given time
period.
• GNP = GDP + income earned from foreign
residents – income paid to foreign residents
• GNP = GDP + net income from foreign
residents (NIF)

Gross national income: GNI = GDI + NIF = GNP, in
theory

GNP = GNI + statistical discrepancy, in practice
12-8
National Income Accounts: Components of
GDP
•
GDP is the market value of expenditure on all final goods
and services produced within the country.
•
This expenditure consists of 4 categories :
1.
Consumption (C): expenditure by domestic residents
2.
Investment (I): expenditure by firms on plants & equipment
3.
Government purchases (G): expenditure by governments on
goods and services
4.
Net exports = exports – imports
–
NX = EX – IM
–
net expenditure by foreigners on domestic goods and services
•
GDP = C + I + G + EX – IM = C + I + G + NX
•
GNP = C + I + G + NX + NIF
12-9
GDP = Expenditure on final goods and
services produced domestically
GDP = Cd + Id + Gd + EX
= (C – Cf) + (I – If) + (G – Gf) + EX
= C + I + G + EX – (Cf + If +Gf)
Cd is consumption
spending on
domestic goods.
Cf is consumption
spending on foreign
goods.
= C + I + G + EX – IM
= C + I + G + NX
Domestic
expenditure
Net expenditure
by foreigners
12-10
Fig. 12-1: U.S. GNP and Its Components
America’s $13.2
trillion 2006 GNP and
its components
Source: US Dept of
Commerce, Bureau of
Economic Analysis.
12-11
Gross National Disposable Income
• Gross National Disposable Income (GNDI) is the total
disposable income of a country’s residents
• GNDI = GNI + gifts received from foreign residents – gifts
given to foreign residents
• NUT = gifts received from foreign residents – gifts given
to foreign residents is called net unilateral transfers
• GNDI = C + I + G + NX + NIF + NUT
• CA = NX + NIF + NUT is called the current account
balance
• GNDI = C + I + G + CA

GNDI is denoted by the symbol Y.
• Y = C + I + G + CA
12-12
GDP, GNP, GNDI: Recap
• GNDI is denoted Y
• Y = GNP + NUT
= GDP + NIF + NUT
= C + I + G + NX + NIF + NUT
= C + I + G + CA
• In practice, net income from foreign residents (NIF)
and net unilateral transfers from foreign residents
(NUT) are usually very small in magnitude
• Therefore, GNDI, GNP and GDP are usually very
similar in magnitude
• Therefore, often they will all be denoted by the
symbol Y.
12-13
National Income Accounts
GNP is not the only measure of a nation’s income:
National Income and GDP are two other measures.
Net National Product = GNP – Depreciation
•
•
•
•
Depreciation of capital is the wear and tear of capital. This results
in a loss of income to capital owners. So the amount of depreciation
is subtracted from GNP.
National Income = NNP – statistical discrepancy



In theory, NNP and national income are the same
NNP is measured using the expenditure approach and
national income (or Net National Income, NNI) is measured
using the income approach, but they both measure the
same thing
The different measuring techniques lead to the statistical
discrepancy
12-14
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
12-16
surplus
US Current Account As a Percentage
of GDP, 1960–2004
2%
1%
0%
-1% 1960
1965
1970
1975
1980
1985
1990
1995
2000
deficit
-2%
-3%
-4%
-5%
-6%
year
Source: Bureau of Economic Analysis, US Department of Commerce
12-17
US Current Account, 1960–2004
billions of current dollars
100
0
-100 1960
1965
1970
1975
1980
1985
1990
1995
2000
-200
-300
-400
-500
-600
-700
year
Source: Bureau of Economic Analysis, US Department of Commerce
12-18
Net Foreign Wealth
• US Net Foreign Wealth = foreign assets
owned by US residents – US assets owned
by foreign residents
• The change in net foreign wealth during a
year depends on
 the
current account balance for that year
 Changes in worldwide asset prices
 Changes in exchange rates (that are used to
convert wealth measured in various currencies
into a common currency)
12-19
Net Foreign Wealth in U.S.
12-20
Fig. 12-2: U.S. Current Account and
Net Foreign Wealth, 1976–2006
US Net Foreign Wealth =
foreign assets owned by US
residents – US assets owned
by foreign residents
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007 release
12-21
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
12-22
National Saving = Private Saving +
Public Saving
S=Y–C–G
The government’s net tax
revenues are denoted T.
S=Y–C–G–T+T
T = tax revenues – transfer
S=Y–T–C+T–G
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
S = Sp + Sg
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
S = Sp + Sg
12-26
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.
12-27
CA = S – I
12-28
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.
12-29
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.
12-30
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
12-31
BALANCE OF PAYMENTS
ACCOUNTS
12-32
Balance of Payments Accounts
• A country’s balance of payments accounts
records its payments to and its receipts from
foreigners.
• Each international transaction enters the
accounts twice:

once as a credit (+) and

once as a debit (-).
12-33
Balance of Payments Accounts (cont.)
• The balance of payment accounts are separated
into 3 broad accounts:

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, or
intangible assets like debt forgiveness, copyrights and
trademarks.
12-34
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.
DVD purchase
–$30
(current account)
Credit (“sale”) of bank account by bank
+$30
(financial account)
12-35
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.
Purchase of stock
–$500
(financial account)
Credit (“sale”) of bank account by bank
+$500
(financial account)
12-36
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
+$100 M
(financial account)
12-37
“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.
12-38
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
• For U.S. data, see this Web site of the Bureau of Economic
Analysis, U.S. Department of Commerce
12-39
Balance of Payments Accounts
• Current account balance =
(exports of goods and services – imports of
goods and services) +
(factor income received from foreigners –
factor income paid to foreigners) +
(gifts of current income received from
foreigners – gifts of current income paid to
foreigners)
• CA = NX + NIF + NUTincome
12-41
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 (-)
12-43
Balance of Payments Accounts (cont.)
• Financial account balance =
capital inflow – capital outflow =
borrowing from foreign residents – lending
to foreign residents
12-44
Balance of Payments Accounts (cont.)
•
Financial account has at least
3 categories:
1.
Official (international) reserve assets
2.
All other assets
3.
Statistical discrepancy
12-45
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 (-).
12-46
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.
12-47
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.
12-48
Official Settlements Balance
Current Account CapitalAccount FinancialAccount 0
FinancialAccount Balanceof Non - ReserveFinancialAccount Balanceof OfficialReserveT ransactions Account
Current Account CapitalAccount BNRFA  BORT A  0
Current Account CapitalAccount BNRFA  - BORT A
- BORT A  OfficialSett lements Balance(or,Balanceof P ayments)
Current Account CapitalAccount BNRFA  OfficialSett lements Balance
• If the official settlements balance is a negative
number, the balance of the official reserve
transactions account must be a positive number.
• In this case the transactions of non-central bank
entities has increased our debt.
• And so, either foreign central banks must help us
out by buying our assets or our central bank must
sell its holdings of foreign assets.
• Thus, a crisis may be in the offing.
12-49
Balance of Payments Accounts (cont.)
• A negative official settlements balance may
indicate that a country is depleting its official
international reserve assets or may be incurring
debts to foreign central banks.
 The
selling of foreign currency by the domestic
central bank and the buying of domestic assets
by foreign central banks are credits for official
international reserve assets, and therefore
reduce the official settlements balance.
12-50
Table 12-2: U.S. Balance of Payments
Accounts for 2006 (billions of dollars)
12-51
Table 12-2: U.S. Balance of Payments
Accounts for 2006 (billions of dollars)
Balance of Official
Reserve Transactions =
2.4 + 440.3 = + 442.7
Official Settlements
Balance = - 442.7.
Also called, Balance of
Payments.
12-52
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 deficit in 2006 was $812
billion dollars.

So, its net foreign wealth continued 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.
12-53
Table 12-3: International Investment Position of
the United States at Year End, 2005 and 2006
(millions of dollars)
12-54
Table 12-3: International Investment Position of
the United States at Year End, 2005 and 2006
(millions of dollars)
12-55
Fig. 12-3: U.S. Gross Foreign Assets and
Liabilities, 1976-2006
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007
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.
12-57
Summary
1. A country’s 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 receipts of
factor income from abroad. It measures the
output produced within a country’s borders.
12-58
Summary (cont.)
4. National saving minus domestic investment equals
the current account (≈ exports minus imports).
5. The current account equals the country’s 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.
12-59
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 bank’s holdings of foreign assets relative to
foreign central banks’ holdings of domestic assets.
9.
The US is the largest debtor nation, and its foreign debt
continues to grow because its current account continues
to be negative.
12-60