The Balance of Payment
National Income Account and
BOP

Y = C + I + G + CA




Y = GDP
C = consumption
G = government spending
CA = current account balance
This is called National Income Identity
Current Account

CA = X – M = net export of goods and
services
X = export; M = import


Strictly speaking CA = X – M +UT but, for
a while, we ignore UT = unilateral transfer
In a closed economy, we do not have CA.
(because X = M = 0)
National Income Account



Consumption
= spending by households, including consumer
spending on durable goods
Investment
= Business sector’s adding to the physical stock
of capital, including inventories. (individual
household’s purchases of stocks, bonds or real
estates are not included)
Government purchases
= spending by federal, state, or local
governments
National Income Account





1999
C
I
G
CA
67.6%
17.5%
17.6%
-2.7%
$6.3 trillion
$1.6
$1.6
-$0.25
Current account balance


(Domestic spending on goods and
services produced domestically)
=C+I+G–M
(Foreign spending on goods and services
produced domestically)
=X
Current account balance (cont’d)




CA = X – M
When X > M or CA > 0, we say current
account surplus.
When X < M or CA < 0, we say current
account deficit.
CA = Y – (C + I + G) = Y – A
where A = domestic absorption
Current account balance (cont’d)
A country with current account deficit is
buying more from foreigners than it sells
to them
It has to increase net foreign debts.
CA = net foreign wealth
 US has been a net debtor since 1985.
In 1998, debt = $5.5 trillion

Saving and Investment
Let S = national saving = Y – C – G.
 Then
S = I + CA
(In a closed economy S = I)
where
I = domestic investment = capital stock
accumulation
CA = foreign wealth acquisition = net foreign
investment
 An open economy can increase investment by
borrowing abroad.

Saving
S = SP + SG
where SP = Yd – C = Y – T – C
SG = T – G
SP = private saving; SG = government saving;
Yd = disposable income; T = net tax.
 Then SP = (C + I + G + CA) – T – C
= I + CA + (G - T)
where G – T = government budget deficit.
 So CA = SP – I – (G – T)
A large gov’t budget deficit leads to a large current

Balance of Payment Accounts



Double-entry bookkeeping
each entry is recorded twice.
A debit entry  a payment to foreigners
A credit entry  a receipt from foreigners
Current Account (CA)
the record of commodity and services transaction


A. Exports (credit)
B. Imports (debit)



1. Merchandise: commodity transaction
2. Services: travel, tourism, royalties, transportation
costs, insurance premiums.
3. Income




Income receipts on US assets abroad (credit)
Income payments on foreign assets in US (debit)
Direct investment receipts and payments
Interest, dividends.
Current Account (cont’d)

C. Unilateral Transfers (debit)



US foreign aid, gifts, retirement pensions, interest
payments to foreigners on their US gov’t debt,
workers’ remittances.
CA > 0: current account surplus
 the country is a net lender to the rest of world
CA < 0: current account deficit
 the country is a net borrower from the rest of
world
Capital Account (KA)
the record of financial assets transaction

A. US assets abroad




1. US official reserve assets (Gold, SDR, reserve in
IMF, foreign currencies)
2. US gov’t assets
3. US private assets (direct investment, foreign
securities)
B. Foreign assets in US


1. Foreign official assets in US (US gov’t securities,
…)
2. Other foreign assets in US (direct investment, US
treasury securities)
Example (a)

An American buys a share of German
stock, paying by writing a $10,000 check
on his account with a Swiss Bank.


Debit: US asset held abroad $10,000
Credit: US asset held abroad $10,000.
For Germany


Credit: Foreign asset held in Germany
Debit: German asset held abroad
Example (b)

An American buys a share of German
stock, paying the seller with a $10,000
check on an American bank.


Debit: US asset held abroad
$10,000
Credit: Foreign asset held in US $10,000
Example (c)

The French government carries out an
official foreign exchange intervention in
which it uses dollars held in an American
bank to buy French currency from its
citizens.


Debit: Foreign asset held in US $1 million
Credit: Foreign asset held in US $1 million
(US official reserve asset)
Example (d)

A tourist from Detroit buys a meal at an
expensive restaurant in Lyons, France,
paying with a VISA credit card. VISA uses
a checking account in France to make
payments.


Debit: Import, Services
Credit: US assets held abroad
$300
$300
Example (e)

A California winegrower contributes a case
of his best cabernet sauvignon for a
London wine tasting.

No market transaction!
Statistical Discrepancy

Theoretically, current account and capital
account should add up to zero. But in
reality, there is a discrepancy due to
errors, time lags, and so on.
Official Reserve Assets

Official reserve assets:



purchase or sale of foreign assets held by the central
bank
Official international reserves: gold, SDR, foreign
currencies, etc.
(current account) + (non-reserve capital
account) + (statistical discrepancy)
= Balance of Payment (official settlement)
Balance of Payment


Balance of Payment (official settlement)
= current account deficit needed to be
covered by the central bank’s official
reserve transactions.
BOP deficit  the country is running down
its official reserves.