Chapter 12

Supplementary Notes

GNP = Expenditure on a Country’s Goods and Services

Y = Cd + Id + Gd + EX

= (C-Cf) + (I-If) + (G-Gf) + EX

= C + I + G + EX – (Cf + If +Gf)

= C + I + G + EX – IM

= C + I + G + CA

Domestic expenditure

Net expenditureby foreigners

expenditureon production

National income = value ofproduction

National Income Accounts: GNP (cont.)

Imports and Exports As a Fraction of GDP

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Canada France Germany Italy Japan Mexico UK US

Per

cen

tag

e o

f G

DP

imports exports

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Canada France Germany Italy Japan Mexico UK US

Per

cen

tag

e o

f G

DP

imports exports

Imports and exports as a percentage of GDP by country, 2000. Source: OECD

GNP and GDP

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

• GNP = GDP + factor payments from foreign countries - factor payments to foreign countries

• GNP = GDP + net factor income from abroad

Expenditure and Productionin an Open Economy

CA = EX – IM = Y – (C + I + G )

• When production > domestic expenditure, exports > imports: current account > 0, 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, 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

US Current Account As a Percentage

of GDP, 1960–2004

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

1960 1965 1970 1975 1980 1985 1990 1995 2000

year

Source: Bureau of Economic Analysis, US Department of Commerce

defic

itsu

rplu

s

US Current Account, 1960–2004

-700

-600

-500

-400

-300

-200

-100

0

100

1960 1965 1970 1975 1980 1985 1990 1995 2000

year

bill

ions

of

curr

ent

doll

ars

Source: Bureau of Economic Analysis, US Department of Commerce

US Current Account and Net Foreign Wealth, 1977–2003

Saving and the Current Account

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

Y – C – G

= (Y – C – T) + (T – G)

S = Sp + Sg

• National saving = private saving + govt saving

How Is the Current Account Related to National Saving?

CA = Y – (C + I + G ) CA = (Y – C – G ) – I

CA = S – I

current account = national saving – investmentcurrent account = net foreign investment

Note: I is domestic investment

• A country that exports more than it imports invests in foreign countries (by lending the CA surplus to foreigners).

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.

– a current account deficit or negative net foreign investment implies a financial capital inflow (through international borrowing).

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

CA = Sp + Sg – I

= Sp – GD – I

• GD, Government deficit (= G – T), is negative govt saving

• A high government deficit causes a negative current account balance, all other things equal.

Inverse Relationship Between Public Saving and Current

Account?

Source: Congressional Budget Office, US Department of Commerce

US current account and public saving relative to GDP, 1960-2004

-8%

-6%

-4%

-2%

0%

2%

4%

1960 1965 1970 1975 1980 1985 1990 1995 2000

Perc

ent o

f GDP

current account public saving

Balance of Payments Accounts

• A country’s balance of payments accounts record its payments to and its receipts from foreigners.

• Record all international transactions in goods, services, assets

Services: travel, transportation, royalties, etc.

Assets: bank loans, deposits, stocks, bonds, etc.

US Balance of Payments Accounts, 2003 in Billions of Dollars

US Balance of Payments Accounts, 2003 in Billions of Dollars (cont.)

3 Broad Accounts

• 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.

Credit and Debit

• Double-entry bookkeeping: Each international transaction enters the BoP accounts twice: once as a credit (+) and once as a debit (-).

• Credit: sale of domestic goods, services, assets to foreigners

• Debit: purchase of foreign goods, services, assets from foreigners

Some useful tips

• Credit: we sell to foreigners• Debit: we buy from foreigners• Treat payment as if we sell the financial assets

(e.g., deposits). Receipts are treated as if our purchase of financial assets.

• The payment part is recorded on the other side of the BoP table.

• Exceptions: unilateral transfers, debt forgiveness

Example 1

• 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(current account)

–$30

Credit (“sale”) of bank account by bank (financial account)

+$30

Example 2

• 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 (financial account)

–$500

Credit (“sale”) of bank account by bank(financial account)

+$500

Example 3

• 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(capital account)

–$100 M

Credit (“sale”) of bank account by bank (financial account)

+$100 M

More Terms• Private financial transactions include direct

investment, portfolio investment (security purchases), and bank claims and liabilities.

• Financial transactions are also classified either short-term or long-term. Long-term means maturity longer than or equal to 1 year.

• “Official” means assets treated as foreign reserves. They include foreign currencies, gold, Special Drawing Rights, and reserve position at the IMF.

• Balance of payments = current a/c + capital a/c + non-reserve financial a/c

Capital inflow and outflow

• Financial (capital) inflow – Foreigners loan to domestic citizens by acquiring domestic

assets. – Foreign owned (sold) assets in the domestic economy are a

credit (+) – A surplus on the financial account implies net inflow of foreign

capital.• Financial (capital) outflow

– Domestic citizens loan to foreigners by acquiring foreign assets. – Domestically owned (purchased) assets in foreign economies

are a debit (-)– A deficit on the financial account implies net outflow of foreign

capital.