1 Section 1 The Balance of Payments

2 Content Objectives The National Income Accounts S, I, and CA The BOP Accounts Bookkeeping Summary

3 Objectives To review national income accounting –The national income accounts record all the income and expenditures of a country. To review balance of payments accounting –The balance of payments accounts record all international transactions of a country.

4 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. –The Output of a country in a given time period.

5 The National Income Accounts Gross Domestic Product (GDP) –The value of all final goods and services produced by the factors of production within a country’s borders. –GDP = GNP - net receipts of factor income from the rest of the world.

6 The National Income Accounts The National Income Identity Y = C + I + G + EX – IM where: Y is GNP C is consumption I is investment G is government purchases EX is exports IM is imports

7 The National Income Accounts Consumption (C) –The share of GNP consumed by the private sector. Investment (I) –The share of GNP used by private firms to produce future output. Government Purchases (G) –The share of GNP used by federal, state, or local governments

8 The National Income Accounts Exports (EX) –The share of GNP exported to the rest of the world. Imports (IM) –The share of GNP imported from the rest of the world.

9 The National Income Accounts The Current Account (CA) –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.

10 Figure 12-1: U.S. GNP and Its Components, 2000

11 Figure 12-2: The U.S. Current Account and Net Foreign Wealth Position,

12 US Current Account and Trade Balance (as a share of GDP) Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis. Note: The vertical bars indicate periods of recession as defined by the National Bureau of Economic Research

13 S, I, and CA National Savings (S) –The share of GNP that is not devoted to household consumption or government purchases. –S = Y – C – G –S = PS + GS

14 S, I, and CA Private Savings (PS) –The share of disposable income saved. –PS = Y – T – C Government Savings –The share of tax revenues (T) saved. –GS = T – G –Government budget deficit: G – T

15 S, I, and CA The key relation: I = S – CA –S = PS + GS –PS = Y – T – C –GS = T – G –CA = EX – IM –Y = C + I + G + EX - IM

16 S, I, and CA The current account is a measure of foreign savings at home. Are current account deficits good? The twin deficits hypothesis.

17 The BOP Accounts The Balance of Payments (BOP) accounts is a record of all transactions between a country and the rest of the world. Every transaction enters the BOP twice: once as a credit (+) and once as a debit (-).

18 The BOP Accounts The Current Account (CA) –The current account divides exports and imports into three categories: Merchandise trade Services Interest and dividend income

19 The BOP Accounts The Capital and Financial Account (KA) –The capital and financial account records the exports and imports of assets. –Capital inflow: An export of assets. –Capital outflow: An import of assets.

20 The BOP Accounts Official Reserve Transactions (ΔRFX) –Official international reserves Foreign assets held by central banks. –Official foreign exchange intervention Exchange rate intervention often requires to alter the amount of official reserves.

21 The BOP Accounts The key relation: CA + KA = ΔRFX This is an accounting identity Accounting: –Exports are recorded as credits (+) in CA, KA –Imports are recorded as debits (-) in CA, KA

22 Bookkeeping Example 1: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. Entries in the U.S. balance of payments: –Purchases (imports) typewriter: Debit CA of $1000. –Sells (exports) asset: Credit to KA of $1000. –CA (-$1000) + KA (+$1000) = 0

23 Bookkeeping Example 2: 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. Entries in the U.S. balance of payments: –Purchases (imports) share: Debit to KA of $95. –Sells (exports) assets: Credit to KA of $95. –CA ($0) + KA (+$95 -$95) = 0

24 Bookkeeping A reduction of official reserves: ΔRFX < 0 –An export of assets by the central bank. An increase of official reserves: ΔRFX > 0 –An import of assets by the central bank. So, changes in RFX similar to transactions in KA.

25 Summary GNP measures the income and production of a country’s factors of production. GDP measures the output produced within a country’s territorial borders. Y = C + I + G + EX – IM I = PS + GS – CA The current account is a measure of the country’s net lending to foreigners.

26 Summary The current account records net exports of goods and services. The capital and financial accounts record net exports of assets. BOP = CA + KA = ΔRFX Exports are recorded as a credit. Imports are recorded as a debit.