Chapter 12

National Income Accounting and the Balance of Payments

November 2009

From rade to Finance! From "icroeconomics to "acroeconomics# $hat%s Ne&' (nem)loyment *aving rade imbalances "oney and the )rice level

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$hat%s in this cha)ter'

National income accounts

National saving! investment and the current account

Balance of )ayments accounts

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National Income Accounts

A country%s national income accounts record ho& income is earned and spent

Producers earn income by selling their goods and services to buyersBuyers s)end &hat they earn from )roductionhe amount of e.)enditure by buyers / the income earned by sellers / the value of )roductionNational income is the total income earned by a nations factors of production.
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Factors of Production
$hat are factors of )roduction'
labor

1&or2ers3! ca)ital 1li2e factories and e4ui)ment3!

)hysical natural other

resources! and

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National Income Accounts# 67P

Gross domestic product 167P3 is the mar2et value of all final goods and services )roduced &ithin a country in a given time )eriod

his is the expenditure definition of 67P8 there are others Intermediate goods are goods that are used in the )roduction of other for-sale goods hey disa))ear inside other goods! as gra)es disa))ear inside &ine! or mil2 inside ice cream! or flour inside bread hese are goods sold to their final users! rather than to )roducers of other for-sale goods he mar2et value of a final good already includes the value of the intermediate goods used in its )roduction-

All other goods are called final goods

Intermediate goods are not counted se)arately

67P counts only final goods in order to avoid counting intermediate goods more than once
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National Income Accounts# 67P

67P / total value added by )roducers located in the country

his is the production definition of 67P :alue added 1by a )roducer3 / mar2et value of goods and services )roduced ; mar2et value of goods and services bought from other )roducers his is the income definition of 67P 6ross domestic income 167I3 is the name given to 67P &hen calculated by statisticians using the income definition In theory 67P / 67IBut in )ractice the numbers usually differ- his difference is called statistical discre)ancy 67P / 67I < statistical discre)ancy

67P / total income generated by domestic )roduction

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National Income Accounts# 6NP

Gross national product 16NP3 is the total income earned by the resources o&ned by the legal residents of a country in a given time )eriod 6NP / 67P < income earned from foreign residents ; income )aid to foreign residents 6NP / 67P < net income from foreign residents 1NIF3

6ross national income# 6NI / 67I < NIF / 6NP! in theory 6NP / 6NI < statistical discre)ancy! in )ractice
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National Income Accounts# >om)onents of 67P

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67P is the mar2et value of e.)enditure on all final goods and services )roduced &ithin the countryhis e.)enditure consists of , categories #
>onsum)tion 1C3# e.)enditure by domestic residents Investment 1I3# e.)enditure by firms on )lants ? e4ui)ment 6overnment )urchases 1G3# e.)enditure by governments on goods and services Net e.)orts / e.)orts ; im)orts
NX = EX IM net e.)enditure by foreigners on domestic goods and services

@ @

GDP = C + I + G + EX IM = C + I + G + NX GNP = C + I + G + NX + NIF

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67P / A.)enditure on final goods and services )roduced domestically GDP = Cd + Id + Gd + EX = 1C Cf3 + 1I If3 + 1G Gf3 + EX = C + I + G + EX 1Cf + If +Gf3
Cd is consumption spending on domestic goods. Cf is consumption spending on foreign goods.

= C + I + G + EX IM =C+I+G+ X
Domestic expenditure Net expenditure by foreigners

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Fig- 12-1# (-*- 6NP and Its >om)onents

America%s B1+-2 trillion 2005 6NP and its com)onents Source: US Dept of Commerce, Bureau of Economic Analysis.

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6ross National 7is)osable Income

6ross National 7is)osable Income 16N7I3 is the total dis)osable income of a country%s residents 6N7I / 6NI < gifts received from foreign residents ; gifts given to foreign residents N( / gifts received from foreign residents ; gifts given to foreign residents is called net unilateral transfers 6N7I / C + I + G + X + I! + "# C$ / X + I! + "# is called the current account balance 6N7I / C + I + G + C$

6N7I is denoted by the symbol %-

% / C + I + G + C$
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67P! 6NP! 6N7I# Ceca)

6N7I is denoted % % / 6NP < "# / 67P + I! + "# / C + I + G + X + I! + "# / C + I + G + C$ In )ractice! net income from foreign residents 1NIF3 and net unilateral transfers from foreign residents 1N( 3 are usually very small in magnitude herefore! 6N7I! 6NP and 67P are usually very similar in magnitude herefore! often they &ill a&& be denoted by the symbol Y12-1+

National Income Accounts

G P is not the only measure of a nation%s income# ationa& Income and GDP are t&o other measuresNet National Product / 6NP ; 7e)reciation
Depreciation of ca)ital is the &ear and tear of ca)ital- his results in a loss of income to ca)ital o&ners- *o the amount of de)reciation is subtracted from 6NP-

National Income / NNP ; statistical discre)ancy

In theory! NNP and national income are the same NNP is measured using the e.)enditure a))roach and national income 1or Net National Income! NNI3 is measured using the income a))roach! but they both measure the same thing he different measuring techni4ues lead to the statistica& discrepancy
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A.)enditure and Production in an D)en Aconomy

Y = C + I + G +CA CA = Y (C + I + G ) $hen domestic )roduction 1%3 E domestic e.)enditure 1C+I+G3! current account / trade balance E 0! e.)orts E im)orts

&hen a country e.)orts more than it im)orts! it earns more income from e.)orts than it s)ends on im)orts- *o! net foreign &ealth increases

$hen domestic )roduction F domestic e.)enditure! e.)orts F im)orts! current account / trade balance F 0

&hen a country e.)orts less than it im)orts! it earns less income from e.)orts than it s)ends on im)orts- *o! net foreign &ealth decreases
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(* >urrent Account As a Percentage of 67P! 1950;200,

2% 1%
su l) r us

0% -1% 1960 -2% -3% -4% -5% -6% year !ource" #ure$u of %conomic &n$'ysis( )! Dep$rtment of *ommerce
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1965

1970

1975

19 0

19 5

1990

1995

2000

ti c i f ed

(* >urrent Account! 1950;200,

100 billions of current dollars 0 -100 1960 -200 -300 -400 -500 -600 -700 year !ource" #ure$u of %conomic &n$'ysis( )! Dep$rtment of *ommerce
1965 1970 1975 19 0 19 5 1990 1995 2000

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Net Foreign $ealth

US Net Foreign Wealth = foreign assets owned by US residents US assets owned by foreign residents he change in net foreign &ealth during a year de)ends on
the

current account balance for that year >hanges in &orld&ide asset )rices >hanges in e.change rates 1that are used to convert &ealth measured in various currencies into a common currency3
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Fig- 12-2# (-*- >urrent Account and Net Foreign $ealth! 1995;2005

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 12-20

*aving and the >urrent Account

National saving 1'3 / national income 1%3 that is not s)ent on consum)tion 1C3 or on government )urchases 1G3 '=%CG '=%#C+#G ' = 1% # C3 + 1# G3 ' = 'p + '(

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Go& Is the >urrent Account Celated to National *aving'

Y / C < I < G < CA Y ; C ; I ; G / CA CA / 1Y ; C ; G 3 ; I / S ; I
current account / national savin invest!ent current account / net forei n invest!ent

A country that im)orts more than it e.)orts has lo& national saving relative to investment12-22

Go& Is the >urrent Account Celated to National *aving' 1cont-3 CA / S ; I or I / S ; CA

>ountries can )ay for investment either by using domestic saving or by borro&ing foreign funds e4ual to the current account deficit

a current account deficit im)lies a financial ca)ital inflo& or negative net foreign investment-

$hen ' ) I! then C$ ) 0 and net foreign investment and financial ca)ital outflo&s for the domestic economy are )ositive12-2+

Go& Is the >urrent Account Celated to National *aving' 1cont-3

CA / S" < S ; I / S" ; government deficit ; I 6overnment deficit is negative government saving

e4ual to 6 ;

A high government deficit causes a negative current account balance! all other things e4ual-

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Inverse Celationshi) Bet&een Public *aving and >urrent Account'

US current account and public saving relative to GDP 1!"#$2##%
,H 2H 0H Percent of GDP -2H -,H -5H -=H 1950 1950 1990 1990 19=0 19=0 1990 1990 2000

current account

)ublic saving

*ource# >ongressional Budget Dffice! (* 7e)artment of >ommerce

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&'(')C* +, P'-.*)/S 'CC+U)/S

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Balance of Payments Accounts

A country%s balance of )ayments accounts records its )ayments to and its recei)ts from foreigners Aach international transaction enters the accounts t&ice#

once as a credit 1<3 and once as a debit 1-3-

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Balance of Payments Accounts 1cont-3

he balance of )ayment accounts are se)arated into + broad accounts#

current account# accounts for flo&s of goods and services 1im)orts and e.)orts3financial account# accounts for flo&s of financial assets 1financial ca)ital3capital account# flo&s of s)ecial categories of assets 1ca)ital3! ty)ically non-mar2et! non-)roduced! or intangible assets li2e debt forgiveness! co)yrights and trademar2s12-2=

A.am)le of Balance of Payment Accounting

Iou im)ort a 7:7 of Ja)anese anime by using your debit card he Ja)anese )roducer of anime de)osits the funds in its ban2 account in *an Francisco- he ban2 credits the account by the amount of the de)osit7:7 )urchase
1current account3 ;B+0

>redit 1KsaleL3 of ban2 account by ban2

1financial account3

<B+0

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A.am)le of Balance of Payment Accounting 1cont-3

Iou invest in the Ja)anese stoc2 mar2et by buying B000 in *ony stoc2 *ony de)osits your funds in its Mos Angeles ban2 account- he ban2 credits the account by the amount of the de)ositPurchase of stoc2
1financial account3 ;B000 <B000

>redit 1KsaleL3 of ban2 account by ban2

1financial account3

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A.am)le of Balance of Payment Accounting 1cont-3

(* ban2s forgive a B100 " debt o&ed by the government of Argentina through debt restructuring (* ban2s &ho hold the debt thereby reduce the debt by crediting ArgentinaNs ban2 accounts7ebt forgiveness# non-mar2et transfer
1ca)ital account3 ;B100 " <B100 "

>redit 1KsaleL3 of ban2 account by ban2

1financial account3

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KBalanceL
Balance / total credits ; total debits
$hen

understood to be a numerical value!

current account stands for ba&ance of t*e current account! capita& account stands for ba&ance of t*e capita& account+ and financia& account stands for ba&ance of t*e financia& account.

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Go& 7o the Balance of Payments Accounts Balance'

7ue to the double entry of each transaction! the overall balance must be ,ero# current account + financia& account + capita& account = -

For (-*- data! see this $eb site of the Bureau of Aconomic Analysis! (-*- 7e)artment of >ommerce
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Balance of Payments Accounts

>urrent account balance / 1e.)orts of goods and services ; im)orts of goods and services3 < 1factor income received from foreigners ; factor income )aid to foreigners3 < 1gifts of current income received from foreigners ; gifts of current income )aid to foreigners3 C$ = X + I! + "#income
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Balance of Payments Accounts 1cont-3

,inancial account = sales of domestic assets to foreigners ; )urchases of foreign assets by domestic citiOens ,inancial inflo0

Foreign citiOens give loans to domestic citiOens by ac4uiring domestic assets- 1<3 Foreigners% )urchase of assets from domestic citiOens are a credit 1<3 7omestic citiOens give loans to foreigners by ac4uiring their assets 1foreign assets3- 1-3 7omestic citiOens% )urchase of assets from foreign citiOens are a debit 1-3

,inancial 1capital2 outflo0

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Balance of Payments Accounts 1cont-3

Financial account balance / ca)ital inflo& ; ca)ital outflo& / borro&ing from foreign residents ; lending to foreign residents

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Balance of Payments Accounts 1cont-3

,inancial account has at least + categories#
1. 23.

+fficial 1international2 reserve assets All other assets Statistical discrepanc4

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Balance of Payments Accounts 1cont-3

+fficial 1international2 reserve assets# foreign assets held by central ban2s to cushion against instability in international mar2ets

Assets include government bonds! currency! gold and accounts at the International "onetary FundDfficial reserve assets sold to foreign central ban2s are a credit 1<3Dfficial reserve assets )urchased by the domestic central ban2 are a debit 1-3-

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Balance of Payments Accounts 1cont-3

Statistical discrepanc4

7ata from a transaction may come from different sources that differ in coverage! accuracy! and timinghe balance of )ayments accounts therefore seldom balance in )racticehe statistical discre)ancy is the account added to or subtracted from the financial account to ma2e it balance &ith the current account and ca)ital account-

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Balance of Payments Accounts 1cont-3 he ne(ati.e of the balance of official reserve assets is called the official settlements balance or Kbalance of )aymentsL It

is the sum of
the current account! the ca)ital account! the non-reserve )ortion of the financial account! and the statistical discre)ancy12-,2

Dfficial *ettlements Balance

*urrent &ccount + *$pit$' &ccount + -in$nci$' &ccount = 0 -in$nci$' &ccount = #$'$nce of Non - ,eser2e -in$nci$' &ccount + #$'$nce of +ffici$' ,eser2e 1r$ns$ctions &ccount *urrent &ccount + *$pit$' &ccount + #N,-& + #+,1& = 0 *urrent &ccount + *$pit$' &ccount + #N,-& = - #+,1& - #+,1& +ffici$' !ett'ements #$'$nce 0or( #$'$nce of .$yments/ *urrent &ccount + *$pit$' &ccount + #N,-& = +ffici$' !ett'ements #$'$nce

If the official settlements balance is a negative number! the balance of the official reserve transactions account must be a )ositive number In this case the transactions of non-central ban2 entities has increased our debt And so! either foreign central ban2s must hel) us out by buying our assets or our central ban2 must sell its holdings of foreign assets hus! a crisis may be in the offing-

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Balance of Payments Accounts 1cont-3

A negative official settlements balance may indicate that a country is de)leting its official international reserve assets or may be incurring debts to foreign central ban2s

he selling of foreign currency by the domestic central ban2 and the buying of domestic assets by foreign central ban2s are credits for official international reserve assets! and therefore reduce the official settlements balance12-,,

able 12-2# (-*- Balance of Payments Accounts for 2005 1billions of dollars3

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able 12-2# (-*- Balance of Payments Accounts for 2005 1billions of dollars3

&alance of +fficial 5eserve /ransactions = 2.% 6 %%#.3 = 6 %%2.7

+fficial Settlements &alance = $ %%2.7. 'lso called &alance of Pa4ments.

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(* Balance of Payments Accounts

he (* has the highest negative net foreign &ealth in the &orld! and is therefore the &orld%s biggest debtor nation-

And its current account deficit in 2005 &as B=12 billion dollars

*o! its net foreign &ealth continued to decrease-

he value of foreign assets held by the (* has gro&n since 19=0! but liabilities of the (* 1debt held by foreigners3 has gro&n more 4uic2ly12-,9

able 12-+# International Investment Position of the (nited *tates at Iear And! 2000 and 2005 1millions of dollars3

>o)yright P 2009 Pearson Addison-$esley- All rights reserved-

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able 12-+# International Investment Position of the (nited *tates at Iear And! 2000 and 2005 1millions of dollars3

>o)yright P 2009 Pearson Addison-$esley- All rights reserved-

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Fig- 12-+# (-*- 6ross Foreign Assets and Miabilities! 1995-2005

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007

(* Balance of Payments Accounts 1cont-3

About 90H of foreign assets held by the (* are denominated in foreign currencies and almost all of (* liabilities 1debt3 are denominated in dollars >hanges in the e.change rate affect the value of net foreign &ealth 1gross foreign assets minus gross foreign liabilities3

A de)reciation of the (* dollar ma2es foreign assets held by the (* more valuable! but does not change the dollar value of dollar denominated debt-

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*ummary
1- A country%s 6NP is roughly e4ual to the income received by its factors of )roduction2- In an o)en economy! 6NP e4uals the sum of consum)tion! investment! government )urchases! and the current account+- 67P is e4ual to 6NP minus net recei)ts of factor income from abroad- It measures the out)ut )roduced &ithin a country%s borders-

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*ummary 1cont-3
,- National saving minus domestic investment e4uals the current account 1Q e.)orts minus im)orts305he current account e4uals the country%s net foreign investment 1net outflo&s of financial assets3he balance of )ayments accounts records flo&s of goods ? services and flo&s of financial assets across countries

It has + )arts# current account! ca)ital account and financial account! &hich balance each otherransactions of goods and services a))ear in the current account8 transactions of financial assets a))ear in the financial account12-0+

*ummary 1cont-3
9Dfficial international reserve assets are a com)onent of the financial account &hich records official assets held by central ban2she official settlements balance is the negative value of official international reserve assets! and it sho&s a central ban2%s holdings of foreign assets relative to foreign central ban2s% holdings of domestic assetshe (* is the largest debtor nation! and its foreign debt continues to gro& because its current account continues to be negative12-0,

=-

9-