Chapter 12

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

National income accounts: –Record expenditures that contribute to a country’s income and output. Balance of payments accounts: –Record the composition of the current account balance and the transactions that finance it.

The National Income Accounts Gross Domestic Product (GDP) = “domestic production” The value of final goods and services produced domestically (i.e., within a country’s borders) in a given time period. Gross National Product (GNP) = “production by national factors” The sum of domestic and foreign expenditure on the goods and services produced by the nations’ factors of production.

“domestic production” ≠ “production by national factors” then GDP ≠ GNP: –E.g., a U.S. factory located in Mexico contributes to Mexico’s GDP but to the United States’ GNP. –GNP = GDP + net receipts of factor income and other ‘unilateral’ transfers from the rest of the world.

GNP equals the total value of final expenditures: GNP = Y = C + I + G + EX - IM(12-1) C = Consumption = amount consumed by private domestic residents I = Investment = amount set aside by private domestic firms for future production * G = Government purchases = amount used by the government EX - IM = exports minus imports of goods and services to foreigners = 0 in a closed economy

Since World War II, on average, in the United States: Consumption  65 percent of GNP Investment  15 percent of GNP Government purchases  20 percent of GNP Net exports  0 percent of GNP

Imports and Exports As a Fraction of GDP

National Income (NI), Trade balance (TB and Current Account (CA) NI=Income earned over a period of time, within or outside a country, by a country’s factors of production. Unless otherwise noted: GNP = National Income = Y TB = EX - IM. CA=TB+ net factor payments and other transfers from abroad. We will ignore this difference in much of our analysis, so that: EX - IM = TB = CA

US Current Account As a Percentage of GDP, 1960–2004 deficit surplus

US Current Account, 1960–2004

External balances in 2004: TB and CA

National Saving –S=the portion of income, Y, not consumed either by households (C) or by the government (G): S = Y - C - G –Since Y=C+G+I+CA, then: S = I + CA –A closed economy (CA=0) can spend its saving on physical capital accumulation: S=I. An open economy can use its saving to (i) add to its capital stock or (ii) acquire foreign wealth: S=I+CA.

A country running a current account deficit is eating off its wealth, held as net foreign assets (NFA), or adding to its net foreign liabilities (and vice versa). Similar to an individual that borrows to finance his current consumption or investment in capital goods. (E.g., student loans...) The change in a country’s NFA equals its CA, or the difference between how much it saves and how much it invests at home: NFA = CA = EX - IM = Y - (C + I + G)=S-I

US Current Account and Net Foreign Wealth, 1977–03

Government contribution to national saving Taxes, T = government’s income. National saving=Private saving S p + government saving, S g : S = S p + S g Private saving: S p = Y - T - C Government saving: S g = T - G CA = S - I = S p + S g - I = (Y - T – C) + (T - G) - I (  12-2) This is an identity not a theory. It only says that we cannot change the government’s budget, T-G, without changing something else. What happens? Two views: 1. “Twin deficit”: a higher public deficit, G-T, worsens the CA. 2. “Ricardian Equivalence”: a higher public deficit is offset by increased savings. (Japan’s stubborn CA surplus as an example.)

Does Government Deficit creates CA deficit?

Sources of current account changes (share of GDP) current statistical = savings - investment + account error = =

Current Account Balance: the 1980s and the 1990s High deficit reflecting low savings in 1980s (bad!) High deficit reflecting high investment since mid-1990s (good!) But also low (public) savings

US CA, Private S & I and Government S:

Balance of Payments Accounts A country’s balance of payments accounts accounts for its payments to and its receipts from foreigners. BOP=CA + FA + KA CA=current account; FA=financial account; KA=capital account Each international transaction enters the accounts twice: once as a credit (+) and once as a debit (-).

Types of international transactions recorded in the BOP CA: Purchases or sales (exports or imports) of goods or services. Exports=receipts from foreigners:+ Imports=payments to foreigners: - FA: Purchases or sales of financial assets (factories, securities, claims on bank accounts, etc.) Outflows of capital= Purchases of assets - Inflows of capital= Sales of assets+ KA: Asset transfers and other non-market transactions (e.g., debt forgiveness). Ex: Debt forgiveness (outflows of funds): - A foreigner transferring funds to the U.S.+

How does the BOP balances? Examples 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

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

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

The Fundamental Balance of Payments Identity Since every international transaction automatically gives rise to two offsetting entries, the balance of payments accounts satisfy a fundamental identity: Current Account Balance + Financial Account Balance + Capital Account Balance = __________________________ 0 (except for statistical discrepancy! which reflects different sources and timing of data)

Case study The Growing U.S. Current Account Deficit

150 Years of U.S. Trade Balance Percent of GDP.

Until 1997 the United States borrowed from advanced economies Non-U.S. advanced economies United States Rest of the world CA, blns of dollars →

Since 1997 the U.S. has drained savings from all the world Non-U.S. advanced economies Rest of the world United States