National Income, Saving, & the Balance of Payments CHAPTER 12

Questions to be Answered What Information is Provided by Items in: ► National Income and Product Accounts ► Balance of Payments Accounts

National Income Account Entries GDP Y GNP C Consumption I Investment G Government Purchases EX Exports IM Imports T Tax Receipts

Related Quantities S Saving CA Current Account Balance G-T Budget Deficit Y-T Disposable Income

Balance of Payments Account Entries CA Current Account Balance EX Exports IM Imports FA Financial Account Balance changes in US Assets Held Abroad changes in Foreign Assets Held in US

GNP (Y) GNP  Output  Income  Spending Value of output = Income (compensation) One person’s spending is another’s income, hence total spending = total income Per capita income = GNP/population & measures the standard of living.

2000 GNP (Billions of U.S. $’s) 1 U.S. 10000 7 France 1500 2 China 4900 8 Russia 1500 3 Japan 3400 9 Italy 1500 4 India 2800 10 Brazil 1500 5 Germany 2000 11 Mexico 900 6 U.K. 1500 12 Canada 900

2000 Population (Millions) 1 U.S. 280 7 France 60 2 China 1250 8 Russia 150 3 Japan 130 9 Italy 60 4 India 1020 10 Brazil 170 5 Germany 80 11 Mexico 100 6 U.K. 60 12 Canada 30

GNP per Capita (U.S. $’s) 1 U.S. 36000 7 France 24000 2 China 3900 8 Russia 10000 3 Japan 26000 9 Italy 23000 4 India 3000 10 Brazil 8000 5 Germany 24000 11 Mexico 10000 6 U.K. 25000 12 Canada 29000

GNP versus GDP GNP – ownership, production by US capital & labor, both here & abroad GDP – location, production within US borders by both US & foreign owned capital & labor GNP = GDP + NFI For US, GNP  GDP Production by US factors abroad  production by foreign factors in US

GNP versus GDP

GNP versus GDP

GNP versus GDP

Demand for Goods in a Closed Economy Demand for goods is Y = C + I + G C – consumption spending by households on durables, nondurables, & services I – investment, purchases of physical investment goods: new houses, buildings, machinery, & inventories. G – government purchases of goods & services

Demand for Goods in a Closed Economy Investment (according to the American Heritage College Dictionary) The act of investing. An amount invested. A property or possession acquired for future financial benefit. A commitment, as of time. A military siege.

The National Income Accounts Figure 12-1: U.S. GNP and Its Components, 2000

United States (billions of $’s) C 6757 68 % I 1833 18 % G 1744 18 % EX 1097 11 % IM 1468 -15 % ⇛Y 9963 100 %

Japan (trillions of ¥’s) C 289 56 % I 133 26 % G 83 16 % EX 52 10 % IM -44 -9 % Y 430 100 %

Closed Economy Saving & Investment Importance of Saving (S) & Investment (I) If S & I , capital formation , productivity , & per capita income 

Closed Economy Saving & Investment Saving is the supply of investment financing, S = SP - (G - T) Private saving (SP) is the initial source of financing SP = (Y - T) - C The government budget deficit (G – T) is the financing used by the government The remainder is available to finance (physical) investment

Closed Economy Saving & Investment Saving is also the supply of investment goods, S = Y - (C + G) Y is production C + G is the goods used by households & government. The remaining goods are available for use as investment goods.

Closed Economy Saving & Investment Algebraically, the supply of investment financing is equal to the supply of investment goods S = SP - (G - T) = (Y - T - C) - (G -T) = Y - C - G In a closed economy, S & I are equal. Y = C + I + G & S = Y – C – G, hence S = I

The National Income Accounts Figure 12-1: U.S. GNP and Its Components, 2000

United States (billions of $’s) C 6757 68 % I 1833 18 % G 1744 18 % EX 1097 11 % IM 1468 -15 % ⇛Y 9963 100 %

Japan (trillions of ¥’s) C 289 56 % I 133 26 % G 83 16 % EX 52 10 % IM -44 -9 % Y 430 100 %

Demand for Goods in an Open Economy Demand for goods is Y = C + I + G + NX C+I+G is domestic demand for goods (spending) Net exports (NX) = exports - imports If NX > 0, we run a trade surplus & international trade  demand If NX < 0, we run a trade deficit & international trade  demand

Current Account Balance (CA) CA  NX = Y – (C + I + G) = (Y – C – G) – I = S – I CA is goods production less domestic demand CA is the excess supply of domestic financing

Current Account (CA) CA surplus implies an outflow of goods, an outflow of financing, & an  in net foreign assets CA deficit implies an inflow of goods, an inflow of financing, & a  in net foreign assets

Recession 2001? GDP 2000 III 9875 2000 IV 9953 2001 I 10028 2001 II 10050 2001 III 10098 2001 IV 10153 2002 I 10313

Recession 2001 nominal real GDP GDP 2000 III 9875 9219 2000 IV 9953 9244 2001 I 10028 9230 2001 II 10050 9193 2001 III 10098 9186 2001 IV 10153 9249 2002 I 10313 9363

Recession 2001 2000 IV 2001 III C 6289 I 1755 G 1593 NX -419 Y 9244 9186

Recession 2001 2000 IV 2001 III C 6289 6371 I 1755 G 1593 NX -419 Y 9244 9186

Recession 2001 2000 IV 2001 III C 6289 6371 I 1755 1563 G 1593 NX -419 Y 9244 9186

Recession 2001 2000 IV 2001 III C 6289 6371 I 1755 1563 G 1593 1633 NX -419 Y 9244 9186

Recession 2001 2000 IV 2001 III C 6289 6371 I 1755 1563 G 1593 1633 NX -419 -419 Y 9244 9186

REVIEW Closed Economy: Open Economy: GNP = Spending = Output = Income Spending = C + I + G Output = C + I + G + NX (= GDP) Income = C + I + G + NX + NFI (= GNP) = C + I + G + CA (= GNP = Y)

Current Account for B-land Spending for Mr. & Mrs. B $100,000 = C; I = G = 0 Combined wages for Mr. & Mrs. B $90000 = Exports C = Imports; NX = -$10000 ⇛ Output = C + I + G + NX (GDP) = $100000 - $10000 = $90000

Current Account for B-land Interest and Dividends for Mr. & Mrs. B: $13000 Interest Payments for Mr. & Mrs. B: $ 1000 ⇛ Net Factor Income = $13000 - $1000 = $12000

Current Account for B-land Current Account Balance = NX + NFI = -$10000 + $12000 = $2000 GNP = GDP + NFI = C + I + G + CA = $90000 + $12000 = $102000 = $100000 + $2000 = $102000 (=Y)

Financial Account for B-land Option 1 Add $2000 to Checking Account ⇛ “Foreign” Assets increase by $2000 ⇛ Financial Account Balance = -$2000 CA + FA = $2000 - $2000 = 0

Financial Account for B-land Option 2 Reduce Visa Balance by $2000 ⇛ “Foreign” Liabilities decrease by $2000 ⇛ Financial Account Balance = -$2000 CA + FA = $2000 - $2000 = 0

Financial Account for B-land Option 3 Put $2000 under bed ⇛ “Foreign” Assets increase by $2000 ⇛ Financial Account Balance = -$2000 CA + FA = $2000 - $2000 = 0

The Balance of Payments Accounts Table 12-2: U.S. Balance of Payments Accounts for 2000

National Income Accounting for an Open Economy Figure 12-2 U.S. CA & Net Foreign Wealth Position, 1977-2000

Is the US the World’s Largest Debtor? Yes, in 1997 net debt was close to $900 billion, the world’s largest However, US net debt was 11% of GNP. Argentine net debt is $120 Billion But this is 40% of GNP (interest is 4% of GNP)

Twin Deficits US Trade Deficits in the 1980’s

Twin Deficits US Trade Deficits in the 1980’s 1980’s - our trade deficits  to 3.5% of GDP due to government budget deficits. In the 1980’s, taxes  & government spending  Thus the demand for goods  & we imported foreign goods Also the demand for financing  & we borrowed from foreigners

Financial Account Gives details of ’s in net foreign assets Financial account balance = sales of US assets to foreigners – purchase of foreign assets by US Mirror image of the CA balance, CA + FA = 0

The Balance of Payments Accounts Table 12-2: Continued credits debits

Current Account Transactions Examples The US buys a $50 sweater from the British, & the British use the $50 to buy a US computer game. (The US trades goods for goods.) Effect on CA? CA = NX + net investment income + net transfers = in net foreign assets

Current Account Transactions Examples A US investor trades a British investor a $50 US bond for a British bond of equivalent value. (The US trades assets for assets.) Effect on CA? CA = NX + net investment income + net transfers = in net foreign assets

Current Account Transactions Examples The US buys a $50 sweater from the British, & the British use the $50 to buy a US government bond. (The US trades assets for goods.) Effect on CA? CA = NX + net investment income + net transfers = in net foreign assets

Current Account Transactions Examples A British tourists sells a US bond & uses the proceeds on a trip to Disney World. (The US trades services for assets.) Effect on CA? CA = NX + net investment income + net transfers = in net foreign assets

Current Account Transactions Examples A US plant in Britain earns 50 pounds & deposits these profits in a London bank (The US trades services for assets.) Effect on CA? CA = NX + net investment income + net transfers = in net foreign assets

Current Account Transactions Examples US gives Israel $5 million in foreign aid, & Israel uses the 5 million to buy US military goods. Effect on CA? CA = NX + net investment income + net transfers =  in net foreign assets