International Finance
Chapter 5
National and International Income Accounting
and
the Balance of Payments
1
Chapter Introduction
• So far, we have studied how exchange rates are
determined in the short run and in the long run.
• As a macroeconomic variable, exchange rates
directly affect international trade in goods and
services as well as international investments and
financial transactions.
• In this chapter, we first study the international
accounting system of trade and payments. Next,
we examine how international transactions relate
to national income and wealth.
2
Chapter Outline
• National income accounts
– GNE, GDP, GNI, & GNDI
– Current account
• National saving, investment, and the current
account
• Balance of payments accounts
3
National Income Accounts
• Gross National Expenditure
GNE = C + I +G
• Expenditure approach gives
GDP = C + I + G + EX – IM
• Trade Balance
TB = EX - IM
– If TB > 0, exports > imports  trade surplus
– If TB < 0, exports < imports  trade deficit
4
National Income Accounts
From GDP to GNI: Accounting for Trade in Factor
Services
• Gross national income equals gross domestic product
(GDP) plus net factor income from abroad (NFIA).
GNI 
C  I G

 ( EX  IM )  ( EX FS  IM FS )



 

Gross nationalexpenditure
GNE
Trade balance
TB

Net factor income from abroad
NFIA
GDP
5
Ireland GDP vs. GNI
A Paper Tiger? The chart
shows trends in GDP, GNI,
and NFIA in Ireland from
1980 to 2011. Irish GNI per
capita grew more slowly than
GDP per capita during the
boom years of the 1980s
and 1990s because an everlarger share of GDP was
sent abroad as net factor
income to foreign investors.
Close to zero in 1980, this
share had risen to around
15% of GDP by the year
2000 and has remained
there.
6
National Income Accounts
From GNI to GNDI: Accounting for Transfers of Income
If a country receives transfers worth UTIN and gives
transfers worth UTOUT, then its net unilateral transfers
(NUT), are
NUT = UTIN − UTOUT .
Adding net unilateral transfers to gross national income,
gives a full measure of national income in an open
economy, known as gross national disposable income
(GNDI), henceforth Y:
7
From GNI to GNDI: Accounting for Transfers of Income
Major Transfer Recipients The
chart shows average figures for
2000 to 2010 for all countries in
which net unilateral transfers
exceeded 15% of GNI. Many of
the countries shown were
heavily reliant on foreign aid,
including some of the poorest
countries in the world, such as
Liberia, Eritrea, Malawi, and
Nepal. Some countries with
higher incomes also have large
transfers because of substantial
migrant remittances
from a large number of emigrant
workers overseas (e.g., Tonga,
El Salvador, Honduras, and
Cape Verde).
8
National Income Accounts
What the National Economic Aggregates Tell Us
• On the left is our full income measure, GNDI.
• The first term on the right is GNE, which measures payments by
home entities.
• The remaining terms measure net payments to the home country
from all international transactions in goods, services, and income.
We group the three cross-border terms into an umbrella term that is
called the current account (CA).
9
National Income Accounts
U.S. Economic Aggregates in 2012 The table shows the computation of GDP, GNI, and
GNDI in 2012 in billions of dollars using the components of gross national expenditure,
the trade balance, international income payments, and unilateral transfers.
10
National Income Accounts
U.S. Current Accounts and Its Components, 1990-2012 The figure shows the
trade balance (TB), net factor income from abroad (NFIA), and net unilateral
transfers (NUT) in billions of dollars.
11
National saving, investment, and the
current account
Y  C  I  G  CA
• This equation is the open-economy national income
identity. It tells us that the current account represents
the difference between national income Y (or GNDI) and
gross
 national expenditure GNE (or C + I + G). Hence:
• GNDI is greater than GNE if and only if CA is positive,
or in surplus.
• GNDI is less than GNE if and only if CA is negative,
or in deficit.
12
National saving, investment, and the
current account
•
•
•
•
Private saving (Sp) = Y – C – T
Public saving (Sg) = T – G
National saving (S) = Sp + Sg = Y – C – G
So, S = I + CA; CA = S – I
– If S > I, the excess saving will be invested in foreign
assets (capital outflow);
– If S < I, the excess investment will have to be financed
by foreign borrowing (capital inflow).
– CA = net foreign investment =  net foreign wealth
13
National saving, investment, and the
current account
Global Imbalances
The charts show
saving (blue),
investment (red),
and the current
account (beige) as
a percent of GDP.
14
National saving, investment, and the
current account
Global Imbalances (continued)
In the 1990s,
emerging markets
moved into current
account surplus
and thus financed
the overall trend
toward current
account deficit of
the industrial
countries.
Note: Oil producers
include Norway.
15
National saving, investment, and the
current account
Private and Public Saving Trends: Industrial Countries
This chart shows
private saving and
the chart on the next
slide public saving,
both as a percent of
GDP. Private saving
has been declining in
the industrial
countries, especially
in Japan (since the
1970s) and in the
United States (since
the 1980s). Private
saving has been
more stable in the
Euro area and other
countries.
16
National saving, investment, and the
current account
Private and Public Saving Trends: Industrial Countries (continued)
Public saving is
clearly more volatile
than private saving.
Japan has been
mostly in surplus and
massively so in the
late 1980s and early
1990s. The United
States briefly ran a
government surplus
in the late 1990s but
has now returned to a
deficit position.
17
Twin Deficits
• CA = Sp – I – (G – T)
– If Sp and I remain constant, a high government deficit
(G – T) generates a high current account deficit.
– In reality, Sp and I probably won’t remain constant.
18
Balance of Payments
• BOP is a report of one country’s transactions with other
countries.
• Double-entry bookkeeping: a transaction enters the
accounts twice: a credit (+) and a debit (-)
– A Payment received is reported as a credit;
– A payment made is reported as a debit.
• Components of BOP
– Current account: flows of goods, services, income, unilateral
transfers;
– Financial account: real assets, financial assets, and official reserve
assets;
– Capital account: non-market, non-produced, or intangible assets;
and statistical discrepancy.
19
Examples of BOP Double-Entry BK
• You invest in the Japanese stock market by
buying $500 in Sony stock.
• Sony deposits the money in its Los Angeles bank
account. The bank credits the account by the
amount of the deposit.
Purchase of stock
(financial account)
Credit (“sale”) of deposit in account by bank
–$500
+$500
(financial account)
20
Examples (Cont.)
• GM exports $2 million worth of automobiles to
China.
• China’s importer pays for the automobiles by
writing a check with its Citi Bank account.
Automobile sales
+$2,000,000
(current account)
Deduction of Chinese importer’s
US$ account at Citi Bank
-$2,000,000
(financial account)
21
Examples (Cont.)
• U.S. banks forgive a $100 M debt owed by the
government of Argentina through debt restructuring.
• U.S. banks who hold the debt thereby reduce the debt
by crediting Argentina's bank accounts.
Debt forgiveness: non-market transfer
(capital account)
Credit (“sale”) of account by bank
(financial account)
–$100 M
+$100 M
22
Examples (Cont.)
• A private charity in the U.S. ships $50,000 worth of
goods as aid following an hurricane that devastated
the southeast region of Taiwan.
23
Examples (Cont.)
• A private charity in the U.S. ships $50,000 worth of
goods as aid following an hurricane that devastated
the southeast region of Taiwan.
Exports of goods from U.S.
(current account)
Unilateral transfer
(financial account)
$50,000
-$50,000
24
The Balance of BOP
• Due to double-entry book keeping, the BOP will
balance as
Current account +
Financial account +
Capital account = 0
25
Balance of Payments
The U.S. Balance of Payments in 2012
The table shows U.S. international transactions in 2012 in billions of
dollars. Major categories are in bold type.
26
Balance of Payments
The U.S. Balance of Payments in 2012 (continued)
The table shows U.S. international transactions in 2012 in billions of
dollars. Major categories are in bold type.
27
Balance of Payments
The U.S. Balance of Payments in 2012 (continued)
The table shows U.S. international transactions in 2012 in billions of
dollars. Major categories are in bold type.
28
Official Reserve Assets
• Official (foreign) reserve assets: foreign assets held by
central banks to cushion against financial instability.
– Assets include government bonds, currency, gold and accounts at
the International Monetary Fund.
– Official reserve assets owned by (sold to) foreign central banks are
a credit (+) because the domestic central bank can spend more
money to cushion against instability.
– Official reserve assets owned by (purchased by) the domestic
central bank are a debit (-) because the domestic central bank can
spend less money to cushion against instability.
29
Official Reserve Assets
• The negative value of the official reserve assets is
called the official settlements balance or
“balance of payments.”
– It is the sum of the current account, the capital account,
the non-reserve portion of the financial account, and the
statistical discrepancy.
– A negative official settlements balance may indicate
that a country
• is depleting its official foreign reserve assets or
• may be incurring large debts to foreign central banks so that
the domestic central bank can spend a lot to protect against
financial instability.
30
Net Foreign Wealth
• A country’s net foreign wealth
 Foreign assets  Home assets owned 
Net foreign wealth = 


 owned by home by rest of the world 
W


 


A
L
• A country’s net foreign wealth is also called its net
international investment position. (Note that it is a stock
measure, not a flow measure).
If W > 0, home is a net creditor country: external
assets exceed external liabilities.
If W < 0, home is a net debtor country: external
liabilities exceed external assets.
31
Net Foreign Wealth
What External Wealth Tells Us
• External wealth data tell us the net credit or debit position
of a country with respect to the rest of the world.
• They include data on external assets (foreign assets
owned by the home country) and external liabilities
(home assets owned by foreigners).
• A creditor country has positive external wealth, a debtor
country has negative external wealth.
• Countries with a current account surplus (deficit) must be
net buyers (sellers) of assets.
32
Net Foreign Wealth
What External Wealth Tells Us (Cont.)
• An increase in a country’s external wealth results from
every net import of assets; conversely, a decrease in
external wealth results from every net export of assets.
• In addition, countries can experience capital gains or
losses on their external assets and liabilities that cause
changes in external wealth.
• All of these changes are summarized in the statement of
a country’s net international investment position.
33
Net Foreign Wealth
• The U.S. has the most negative net foreign wealth
in the world, and so is therefore the world’s largest
debtor nation.
• Its current account deficit in 2014 was $389.5
billion dollars, so net foreign wealth continues to
decrease.
• The value of foreign assets held by the
U.S. has grown since 1980, but liabilities of
the U.S. (debt held by foreigners) has grown
faster.
34
U.S. Gross Foreign Assets and Liabilities
($billions), 1976 - 2014
Source: U.S. Department of Commerce, Bureau of Economic Analysis,
35
Net Foreign Wealth
• About 70% of foreign assets held by the U.S. are
denominated in foreign currencies and almost all
of U.S. liabilities (debt) are denominated in
dollars.
• Changes in the exchange rate influence value of
net foreign wealth (gross foreign assets minus
gross foreign liabilities).
– Appreciation of the value of foreign currencies makes
foreign assets held by the U.S. more valuable, but does
not change the dollar value of dollar-denominated debt
for the U.S.
36