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Chapter 13

National Income Accounting and �the Balance �of Payments

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Preview

National income accounts

measures of national income
measures of value of production
measures of value of expenditure

National saving, investment, and the current account
Balance of payments accounts

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National Income Accounts

Records the value of national income that results from production and expenditure.

Producers earn income from buyers who spend money on goods and services.
The amount of expenditure by buyers = �the amount of income for sellers = �the value of production.
National income is often defined to be the income earned by a nation’s factors of production.

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National Income Accounts: GNP

Gross national product (GNP) is the value of all final goods and services produced by a nation’s factors of production in a given �time period.

What are factors of production? Factors that are used to produce goods and services: workers (labor services), physical capital (like buildings and equipment), natural resources and others.
The value of final goods and services produced by US-owned factors of production are counted as US GNP.

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National Income Accounts: GNP (cont.)

GNP is calculated by adding the value of expenditure on final goods and services produced:

Consumption: expenditure by domestic consumers
Investment: expenditure by firms on buildings & equipment
Government purchases: expenditure by governments on goods and services
Current account balance (exports minus imports): net expenditure by foreigners on domestic goods and services

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Fig. 13-1: U.S. GNP and Its Components

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

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National Income Accounts

GNP is one measure of national income, but a more precise measure of national income is GNP adjusted for following:

Depreciation
Unilateral transfers.

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National Income Accounts (cont.)

Another approximate measure of national income is gross domestic product (GDP):

– Gross domestic product measures the final value of all goods and services that are produced within a country in a given time period.

– GDP = GNP – payments from foreign countries for factors of production + payments to foreign countries for factors of production

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GNP = Expenditure on a Country’s Goods and Services

The national income identity for an open economy is

Y = C + I + G + EX – IM

= C + I + G + CA

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Expenditure by domestic individuals and institutions

Net expenditure by foreign individuals and institutions

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Expenditure and Production in an Open Economy

CA = EX – IM = Y – (C + I + G )

When production > domestic expenditure, exports > imports: current account > 0 and trade balance > 0

when a country exports more than it imports, it earns more income from exports than it spends on imports
net foreign wealth is increasing

When production < domestic expenditure, exports < imports: current account < 0 and trade balance < 0

when a country exports less than it imports, it earns less income from exports than it spends on imports
net foreign wealth is decreasing

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Saving and the Current Account

National saving (S) = national income (Y) that is not spent on consumption (C) or government purchases (G).

S = Y – C – G

S = (Y – C – T) + (T – G)

S = S^p + S^g

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Fig. 13-2: U.S. Current Account and Net Foreign Wealth, 1976–2009

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

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How Is the Current Account Related to National Saving?

CA = Y – (C + I + G )

= (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.

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How Is the Current Account Related to National Saving? (cont.)

CA = S – I or I = S – CA

Countries can finance investment either by saving or by acquiring foreign funds equal to the current account deficit.
When S > I, then CA > 0 so that net foreign investment and financial capital outflows for the domestic economy are positive.

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How Is the Current Account Related to National Saving? (cont.)

CA = S^p + S^g – I

= S^p – government deficit – I

Government deficit is negative government saving

equal to G – T

A high government deficit causes a �negative current account balance when other factors remain constant.

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Balance of Payments Accounts

A country’s balance of payments accounts accounts for its payments to and its receipts from foreigners.
An international transaction involves two parties, and each transaction enters the accounts twice: once as a credit (+) and once as a debit (–).

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Balance of Payments Accounts (cont.)

The balance of payments 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 nonmarket, non-produced, or intangible assets like debt forgiveness, copyrights and trademarks.

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How Do the Balance of Payments Accounts Balance?

Due to the double entry of each transaction, the balance of payments accounts will balance by the following equation:

current account +

financial account +

capital account = 0

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Balance of Payments Accounts

The 3 broad accounts are more finely divided:

Current account: imports and exports

merchandise (goods like DVDs)
services (payments for legal services, shipping services, tourist meals, etc.)
income receipts (interest and dividend payments, earnings of firms and workers operating in foreign countries)

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Balance of Payments Accounts (cont.)

Current account: net unilateral transfers

gifts (transfers) across countries that do not purchase a good or service nor serve as income for goods and services produced

Capital account: records special transfers of assets, but this is a minor account for the U.S.

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Balance of Payments Accounts (cont.)

Financial account: the difference between sales of domestic assets to foreigners and purchases of foreign assets by domestic citizens.
Financial inflow

Foreigners loan to domestic citizens by buying domestic assets.
Domestic assets sold to foreigners are a credit (+) because the domestic economy acquires money during the transaction.

Financial outflow

Domestic citizens loan to foreigners by buying foreign assets.
Foreign assets purchased by domestic citizens are a debit (–) because the domestic economy gives up money during the transaction.

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Balance of Payments Accounts (cont.)

Financial account has at least 3 subcategories:

Official (international) reserve assets
All other assets
Statistical discrepancy

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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.

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Balance of Payments Accounts (cont.)

Official (international) reserve assets: foreign assets held by central banks to cushion against financial instability.

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Balance of Payments Accounts (cont.)

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 nonreserve portion of the financial account, and the statistical discrepancy.
A negative official settlements balance may indicate that a country

is depleting its official international 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.

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Table 13-2: U.S. Balance of Payments Accounts for 2009 (billions of dollars)

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U.S. Balance of Payments Accounts

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 2009 was $378 billion dollars, so that 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.

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Fig. 13-3: U.S. Gross Foreign Assets and Liabilities, 1976-2009

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2010.

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