Chapter 12
National Income Accounting and the
Balance of Payments
2
Chapter Organization
Introduction
The National Income Accounts
National Income Accounting for an Open
Economy
The Balance of Payment Accounts
Summary
3
Introduction
Microeconomics
– It studies the effective use of scarce resources from the
perspective of individual firms and consumers.
Macroeconomics
– It studies how economies’ overall levels of employment,
production,and growth are determined.
– It emphasizes four aspects of economic life:
Unemployment
Saving
Trade imbalances
Money and the price level
4
The national income accounts and the balance of
payments accounts are essential tools for studying the
macroeconomics of open,interdependent economies.
National income accounting
– Records all the expenditures that contribute to a country’s
income and output
Balance of payments accounting
– Helps us keep track of both changes in a country’s
indebtedness to foreigners and the fortunes of its export-
and import-competing industries
Introduction
5
The National Income Accounts
Gross national product (GNP)
– The value of all final goods and services produced
by a country’s factors of production and sold on
the market in a given time period
– It is the basic measure of a country’s output.
6
GNP is calculated by adding up the market value of
all expenditures on final output:
– Consumption
The amount consumed by private domestic residents
– Investment
The amount put aside by private firms to build new plant and
equipment for future production
– Government purchases
The amount used by the government
– Current account balance
The amount of net exports of goods and services to foreigners
The National Income Accounts
7
The National Income Accounts
Figure 12-1,U.S,GNP and Its Components,2000
8
National Product and National Income
– National Income
It is earned over a period by its factors of production.
It must equal the GNP a country generates over
some period of time.
One person’s spending is another’s income (i.e.,total
spending must equal total income).
The National Income Accounts
9
Capital Depreciation,International Transfers,
and Indirect Business Taxes
– Adjustments to the definition of GNP:
Depreciation of capital
It reduces the income of capital owners.
It must be subtracted from GNP (to get the net national product).
Net unilateral transfers of income
They are part of a country’s income but are not part of its product.
They must be added to the net national product.
Indirect business taxes
They are sales taxes.
They must be subtracted from GNP.
The National Income Accounts
10
Gross Domestic Product (GDP)
– It measures the volume of production within a
country’s borders.
– It equals GNP minus net receipts of factor
income from the rest of the world.
– It does not correct for the portion of countries’
production carried out using services provided
by foreign-owned capital.
The National Income Accounts
11
National Income Accounting
for an Open Economy
Consumption
– The portion of GNP purchased by the private
sector to fulfill current wants
Investment
– The part of output used by private firms to
produce future output
Government Purchases
– Any goods and services purchased by federal,
state,or local governments
12
The National Income Identity for an Open Economy
– It is the sum of domestic and foreign expenditure on the
goods and services produced by domestic factors of
production:
Y = C + I + G + EX – IM (12-1)
where:
Y is GNP
C is consumption
I is investment
G is government purchases
EX is exports
IM is imports
– In a closed economy,EX = IM = 0.
National Income Accounting
for an Open Economy
13
An Imaginary Open Economy
– Assumptions of the model:
There is an economy,Agraria,that can only produce
wheat.
Each citizen of Agraria is both a consumer and a farmer
of wheat.
The Agrarian government appropriates part of the crop
to feed its army.
Agraria can import milk from the rest of the world in
exchange for exports of wheat.
The price of milk is 0.5 bushel of wheat per gallon,and at this
price Agrarians want to consume 40 gallons of milk.
National Income Accounting
for an Open Economy
14
Table 12-1,National Income Accounts for Agraria,an Open Economy
(bushels of wheat)
National Income Accounting
for an Open Economy
15
The Current Account and Foreign
Indebtedness
– Current account (CA) balance
The difference between exports of goods and services
and imports of goods and services (CA = EX – IM)
A country has a CA surplus when its CA > 0.
A country has a CA deficit when its CA < 0.
CA measures the size and direction of international
borrowing.
A country’s current account balance equals the change in its
net foreign wealth.
National Income Accounting
for an Open Economy
16
– CA balance is equal to the difference between
national income and domestic residents’ spending:
Y – (C+ I + G) = CA
CA balance is goods production less domestic demand,
CA balance is the excess supply of domestic financing,
Example,Agraria imports 20 bushels of wheat and exports only
10 bushels of wheat (Table 12-1),The current account deficit of
10 bushels is the value of Agraria’s borrowing from foreigners,
which the country will have to repay in the future.
National Income Accounting
for an Open Economy
17
Figure 12-2,The U.S,Current Account and Net Foreign Wealth Position,
1977-2000
National Income Accounting
for an Open Economy
18
Saving and the Current Account
– National saving (S)
The portion of output,Y,that is not devoted to household
consumption,C,or government purchases,G.
It always equals investment in a closed economy.
A closed economy can save only by building up its capital stock
(S = I).
An open economy can save either by building up its capital stock
or by acquiring foreign wealth (S = I + CA).
A country’s CA surplus is referred to as its net foreign
investment.
National Income Accounting
for an Open Economy
19
Private and Government Saving
– Private saving (Sp)
The part of disposable income that is saved rather than
consumed
Sp = I + CA – Sg = I + CA – (T – G) = I + CA + (G – T)
(12-2)
T is the government's,income” (its net tax revenue)
Sg is government savings (T-G)
– Government budget deficit (G – T)
It measures the extent to which the government is
borrowing to finance its expenditures.
National Income Accounting
for an Open Economy
20
The Balance of Payments
Accounts
A country’s balance of payments accounts keep
track of both its payments to and its receipts
from foreigners.
Every international transaction automatically
enters the balance of payments twice,once as a
credit (+) and once as a debit (-).
21
Three types of international transactions are
recorded in the balance of payments:
– Exports or imports of goods or services
– Purchases or sales of financial assets
– Transfers of wealth between countries
They are recorded in the capital account.
The Balance of Payments
Accounts
22
Examples of Paired Transactions
– A U.S,citizen buys a $1000 typewriter from an
Italian company,and the Italian company deposits
the $1000 in its account at Citibank in New York.
That is,the U.S,trades assets for goods.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,CA with a negative sign (-$1000).
It shows up as a $1000 credit in the U.S,financial account.
The Balance of Payments
Accounts
23
– A U.S,citizen pays $200 for dinner at a French
restaurant in France by charging his Visa credit
card.
That is,the U.S,trades assets for services.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,CA with a negative sign (-$200).
It shows up as a $200 credit in the U.S,financial account.
The Balance of Payments
Accounts
24
– A U.S,citizen buys a $95 newly issued share of
stock in the United Kingdom oil giant British
Petroleum (BP) by using a check drawn on his
stockbroker money market account,BP deposits
the $95 in its own U.S,bank account at Second
Bank of Chicago.
That is,the U.S,trades assets for assets.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,financial account with a negative sign (-$95).
It shows up as a $95 credit in the U.S,financial account.
The Balance of Payments
Accounts
25
– A U.S,bank forgives $5000 in debt owed to it by
the government of Bygonia.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,capital account with a negative sign (-$5000).
It shows up as a $5000 credit in the U.S,financial account.
The Balance of Payments
Accounts
26
The Fundamental Balance of Payments
Identity
– Any international transaction automatically
gives rise to two offsetting entries in the
balance of payments resulting in a fundamental
identity:
Current account + financial account + capital
account = 0 (12-3)
The Balance of Payments
Accounts
27
The Balance of Payments Accounts
Table 12-2,U.S,Balance of Payments Accounts for 2000
(billions of dollars)
28
The Balance of Payments Accounts
Table 12-2,Continued
29
The Current Account,Once Again
– The balance of payments accounts divide exports
and imports into three categories:
Merchandise trade
Exports or imports of goods
Services
Payments for legal assistance,tourists’ expenditures,and
shipping fees
Income
International interest and dividend payments and the earnings
of domestically owned firms operating abroad
The Balance of Payments Accounts
30
The Capital Account
– It records asset transfers and tends to be small for
the United States.
The Financial Account
– It measures the difference between sales of assets
to foreigners and purchases of assets located abroad.
Financial inflow (capital inflow)
A loan from the foreigners with a promise that they will be
repaid
Financial outflow (capital outflow)
A transaction involving the purchase of an asset from foreigners
The Balance of Payments Accounts
31
The Statistical Discrepancy
– Data associated with a given transaction may come
from different sources that differ in coverage,
accuracy,and timing,
This makes the balance of payments accounts seldom
balance in practice.
Account keepers force the two sides to balance by
adding to the accounts a statistical discrepancy.
It is very difficult to allocate this discrepancy among the
current,capital,and financial accounts.
The Balance of Payments Accounts
32
Official Reserve Transactions
– Central bank
The institution responsible for managing the supply of
money
– Official international reserves
Foreign assets held by central banks as a cushion
against national economic misfortune
– Official foreign exchange intervention
Central banks often buy or sell international reserves in
private asset markets to affect macroeconomic
conditions in their economies.
The Balance of Payments Accounts
33
– Official settlements balance (balance of
payments)
The book-keeping offset to the balance of official
reserve transactions
It is the sum of the current account balance,the capital
account balance,the nonreserve portion of the financial
account balance,and the statistical discrepancy.
Example,The U.S,balance of payments in 2000 was -$35.6
billion,that is,the balance of official reserve transactions with
its sign reversed.
A country with a negative balance of payments may
signal that it is running down its international reserve
assets or incurring debts to foreign monetary authorities.
The Balance of Payments Accounts
34
The Balance of Payments Accounts
Table 12-3,Calculating the U.S,Official Settlements Balance for 2000
(billions of dollars)
35
The Balance of Payments Accounts
Table 12-3,Continued
36
Case Study,Is the United States the
World’s Biggest Debtor?
– At the end of 1999,the United States had a
negative net foreign wealth position far greater
than that of any other single country.
– The United States is the world’s biggest debtor.
– However,the United States has the world’s
largest GNP.
The Balance of Payments Accounts
37
The Balance of Payments Accounts
Table 12-4,International Investment Position of the United States at
Year End,1998 and 1999 (millions of dollars)
38
The Balance of Payments Accounts
Table 12-4,Continued
39
Summary
A country’s GNP is equal to the income received
by its factors of production.
– GDP is equal to GNP less net receipts of factor income
from abroad,measures the output produced within a
country’s territorial borders.
In a closed economy,GNP must be consumed,
invested,or purchased by the government.
– In an open economy,GNP equals the sum of
consumption,investment,government purchases,and
net exports of goods and services.
40
Summary
All transactions between a country and the rest
of the world are recorded in its balance of
payments accounts.
The current account equals the country’s net
lending to foreigners,
– National saving equals domestic investment plus
the current account.
– Transactions involving goods and services appear
in the current account of the balance of payments,
while international sales or purchases of assets
appear in the financial account.
41
Summary
The capital account records asset transfers and
tends to be small in the United States.
Any current account deficit must be matched by
an equal surplus in the other two accounts of the
balance of payments,and any current account
surplus by a deficit somewhere else.
International asset transactions carried out by
central banks are included in the financial account.
National Income Accounting and the
Balance of Payments
2
Chapter Organization
Introduction
The National Income Accounts
National Income Accounting for an Open
Economy
The Balance of Payment Accounts
Summary
3
Introduction
Microeconomics
– It studies the effective use of scarce resources from the
perspective of individual firms and consumers.
Macroeconomics
– It studies how economies’ overall levels of employment,
production,and growth are determined.
– It emphasizes four aspects of economic life:
Unemployment
Saving
Trade imbalances
Money and the price level
4
The national income accounts and the balance of
payments accounts are essential tools for studying the
macroeconomics of open,interdependent economies.
National income accounting
– Records all the expenditures that contribute to a country’s
income and output
Balance of payments accounting
– Helps us keep track of both changes in a country’s
indebtedness to foreigners and the fortunes of its export-
and import-competing industries
Introduction
5
The National Income Accounts
Gross national product (GNP)
– The value of all final goods and services produced
by a country’s factors of production and sold on
the market in a given time period
– It is the basic measure of a country’s output.
6
GNP is calculated by adding up the market value of
all expenditures on final output:
– Consumption
The amount consumed by private domestic residents
– Investment
The amount put aside by private firms to build new plant and
equipment for future production
– Government purchases
The amount used by the government
– Current account balance
The amount of net exports of goods and services to foreigners
The National Income Accounts
7
The National Income Accounts
Figure 12-1,U.S,GNP and Its Components,2000
8
National Product and National Income
– National Income
It is earned over a period by its factors of production.
It must equal the GNP a country generates over
some period of time.
One person’s spending is another’s income (i.e.,total
spending must equal total income).
The National Income Accounts
9
Capital Depreciation,International Transfers,
and Indirect Business Taxes
– Adjustments to the definition of GNP:
Depreciation of capital
It reduces the income of capital owners.
It must be subtracted from GNP (to get the net national product).
Net unilateral transfers of income
They are part of a country’s income but are not part of its product.
They must be added to the net national product.
Indirect business taxes
They are sales taxes.
They must be subtracted from GNP.
The National Income Accounts
10
Gross Domestic Product (GDP)
– It measures the volume of production within a
country’s borders.
– It equals GNP minus net receipts of factor
income from the rest of the world.
– It does not correct for the portion of countries’
production carried out using services provided
by foreign-owned capital.
The National Income Accounts
11
National Income Accounting
for an Open Economy
Consumption
– The portion of GNP purchased by the private
sector to fulfill current wants
Investment
– The part of output used by private firms to
produce future output
Government Purchases
– Any goods and services purchased by federal,
state,or local governments
12
The National Income Identity for an Open Economy
– It is the sum of domestic and foreign expenditure on the
goods and services produced by domestic factors of
production:
Y = C + I + G + EX – IM (12-1)
where:
Y is GNP
C is consumption
I is investment
G is government purchases
EX is exports
IM is imports
– In a closed economy,EX = IM = 0.
National Income Accounting
for an Open Economy
13
An Imaginary Open Economy
– Assumptions of the model:
There is an economy,Agraria,that can only produce
wheat.
Each citizen of Agraria is both a consumer and a farmer
of wheat.
The Agrarian government appropriates part of the crop
to feed its army.
Agraria can import milk from the rest of the world in
exchange for exports of wheat.
The price of milk is 0.5 bushel of wheat per gallon,and at this
price Agrarians want to consume 40 gallons of milk.
National Income Accounting
for an Open Economy
14
Table 12-1,National Income Accounts for Agraria,an Open Economy
(bushels of wheat)
National Income Accounting
for an Open Economy
15
The Current Account and Foreign
Indebtedness
– Current account (CA) balance
The difference between exports of goods and services
and imports of goods and services (CA = EX – IM)
A country has a CA surplus when its CA > 0.
A country has a CA deficit when its CA < 0.
CA measures the size and direction of international
borrowing.
A country’s current account balance equals the change in its
net foreign wealth.
National Income Accounting
for an Open Economy
16
– CA balance is equal to the difference between
national income and domestic residents’ spending:
Y – (C+ I + G) = CA
CA balance is goods production less domestic demand,
CA balance is the excess supply of domestic financing,
Example,Agraria imports 20 bushels of wheat and exports only
10 bushels of wheat (Table 12-1),The current account deficit of
10 bushels is the value of Agraria’s borrowing from foreigners,
which the country will have to repay in the future.
National Income Accounting
for an Open Economy
17
Figure 12-2,The U.S,Current Account and Net Foreign Wealth Position,
1977-2000
National Income Accounting
for an Open Economy
18
Saving and the Current Account
– National saving (S)
The portion of output,Y,that is not devoted to household
consumption,C,or government purchases,G.
It always equals investment in a closed economy.
A closed economy can save only by building up its capital stock
(S = I).
An open economy can save either by building up its capital stock
or by acquiring foreign wealth (S = I + CA).
A country’s CA surplus is referred to as its net foreign
investment.
National Income Accounting
for an Open Economy
19
Private and Government Saving
– Private saving (Sp)
The part of disposable income that is saved rather than
consumed
Sp = I + CA – Sg = I + CA – (T – G) = I + CA + (G – T)
(12-2)
T is the government's,income” (its net tax revenue)
Sg is government savings (T-G)
– Government budget deficit (G – T)
It measures the extent to which the government is
borrowing to finance its expenditures.
National Income Accounting
for an Open Economy
20
The Balance of Payments
Accounts
A country’s balance of payments accounts keep
track of both its payments to and its receipts
from foreigners.
Every international transaction automatically
enters the balance of payments twice,once as a
credit (+) and once as a debit (-).
21
Three types of international transactions are
recorded in the balance of payments:
– Exports or imports of goods or services
– Purchases or sales of financial assets
– Transfers of wealth between countries
They are recorded in the capital account.
The Balance of Payments
Accounts
22
Examples of Paired Transactions
– A U.S,citizen buys a $1000 typewriter from an
Italian company,and the Italian company deposits
the $1000 in its account at Citibank in New York.
That is,the U.S,trades assets for goods.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,CA with a negative sign (-$1000).
It shows up as a $1000 credit in the U.S,financial account.
The Balance of Payments
Accounts
23
– A U.S,citizen pays $200 for dinner at a French
restaurant in France by charging his Visa credit
card.
That is,the U.S,trades assets for services.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,CA with a negative sign (-$200).
It shows up as a $200 credit in the U.S,financial account.
The Balance of Payments
Accounts
24
– A U.S,citizen buys a $95 newly issued share of
stock in the United Kingdom oil giant British
Petroleum (BP) by using a check drawn on his
stockbroker money market account,BP deposits
the $95 in its own U.S,bank account at Second
Bank of Chicago.
That is,the U.S,trades assets for assets.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,financial account with a negative sign (-$95).
It shows up as a $95 credit in the U.S,financial account.
The Balance of Payments
Accounts
25
– A U.S,bank forgives $5000 in debt owed to it by
the government of Bygonia.
This transaction creates the following two offsetting
entries in the U.S,balance of payments:
It enters the U.S,capital account with a negative sign (-$5000).
It shows up as a $5000 credit in the U.S,financial account.
The Balance of Payments
Accounts
26
The Fundamental Balance of Payments
Identity
– Any international transaction automatically
gives rise to two offsetting entries in the
balance of payments resulting in a fundamental
identity:
Current account + financial account + capital
account = 0 (12-3)
The Balance of Payments
Accounts
27
The Balance of Payments Accounts
Table 12-2,U.S,Balance of Payments Accounts for 2000
(billions of dollars)
28
The Balance of Payments Accounts
Table 12-2,Continued
29
The Current Account,Once Again
– The balance of payments accounts divide exports
and imports into three categories:
Merchandise trade
Exports or imports of goods
Services
Payments for legal assistance,tourists’ expenditures,and
shipping fees
Income
International interest and dividend payments and the earnings
of domestically owned firms operating abroad
The Balance of Payments Accounts
30
The Capital Account
– It records asset transfers and tends to be small for
the United States.
The Financial Account
– It measures the difference between sales of assets
to foreigners and purchases of assets located abroad.
Financial inflow (capital inflow)
A loan from the foreigners with a promise that they will be
repaid
Financial outflow (capital outflow)
A transaction involving the purchase of an asset from foreigners
The Balance of Payments Accounts
31
The Statistical Discrepancy
– Data associated with a given transaction may come
from different sources that differ in coverage,
accuracy,and timing,
This makes the balance of payments accounts seldom
balance in practice.
Account keepers force the two sides to balance by
adding to the accounts a statistical discrepancy.
It is very difficult to allocate this discrepancy among the
current,capital,and financial accounts.
The Balance of Payments Accounts
32
Official Reserve Transactions
– Central bank
The institution responsible for managing the supply of
money
– Official international reserves
Foreign assets held by central banks as a cushion
against national economic misfortune
– Official foreign exchange intervention
Central banks often buy or sell international reserves in
private asset markets to affect macroeconomic
conditions in their economies.
The Balance of Payments Accounts
33
– Official settlements balance (balance of
payments)
The book-keeping offset to the balance of official
reserve transactions
It is the sum of the current account balance,the capital
account balance,the nonreserve portion of the financial
account balance,and the statistical discrepancy.
Example,The U.S,balance of payments in 2000 was -$35.6
billion,that is,the balance of official reserve transactions with
its sign reversed.
A country with a negative balance of payments may
signal that it is running down its international reserve
assets or incurring debts to foreign monetary authorities.
The Balance of Payments Accounts
34
The Balance of Payments Accounts
Table 12-3,Calculating the U.S,Official Settlements Balance for 2000
(billions of dollars)
35
The Balance of Payments Accounts
Table 12-3,Continued
36
Case Study,Is the United States the
World’s Biggest Debtor?
– At the end of 1999,the United States had a
negative net foreign wealth position far greater
than that of any other single country.
– The United States is the world’s biggest debtor.
– However,the United States has the world’s
largest GNP.
The Balance of Payments Accounts
37
The Balance of Payments Accounts
Table 12-4,International Investment Position of the United States at
Year End,1998 and 1999 (millions of dollars)
38
The Balance of Payments Accounts
Table 12-4,Continued
39
Summary
A country’s GNP is equal to the income received
by its factors of production.
– GDP is equal to GNP less net receipts of factor income
from abroad,measures the output produced within a
country’s territorial borders.
In a closed economy,GNP must be consumed,
invested,or purchased by the government.
– In an open economy,GNP equals the sum of
consumption,investment,government purchases,and
net exports of goods and services.
40
Summary
All transactions between a country and the rest
of the world are recorded in its balance of
payments accounts.
The current account equals the country’s net
lending to foreigners,
– National saving equals domestic investment plus
the current account.
– Transactions involving goods and services appear
in the current account of the balance of payments,
while international sales or purchases of assets
appear in the financial account.
41
Summary
The capital account records asset transfers and
tends to be small in the United States.
Any current account deficit must be matched by
an equal surplus in the other two accounts of the
balance of payments,and any current account
surplus by a deficit somewhere else.
International asset transactions carried out by
central banks are included in the financial account.
