National Income Accounts and Balance of Payments Accounting

Expenditure Measures Absorption is the sum of purchases by three sectors of the economy: household, corporate, and government sectors. Current dollar absorption P A A ≡ P C C + P I I + P G G Constant dollar absorption A ≡ C + I + G

Absorption Deflator Deflators are the ratio of current dollar to constant dollar. Absorption deflator is a weighted average of different category deflators.

Categories C- Personal Consumption Expenditure Consumer Durables Consumer Non-Durables Consumer Services I – Gross Capital Formation Change in Stocks - Inventories Gross Fixed Capital Formation Residential Investment Non-Residential Investment Structures Machinery & Equipment G – Government Expenditure

Net Exports Domestic goods can also be sold overseas, while domestic absorption can also be satisfied by imports. The nominal trade balance is P NX NX = P EX EX - P IM IM The real trade balance is NX = EX - IM

GDP GDP goods produced domestically are equal to those goods sold domestically less domestic demand satisfied by imports plus domestic goods. P Q Q = P C C + P I I + P G G + P EX EX – P IM IM Q = C + I + G + EX - IM

Domestic Income Income from domestic residents (GNP) may come from domestic or foreign sources. Also, income generated from domestic sources (GDP) may go, in part, to foreign owners, creditors, or workers. Net Transfers (NT) is income from foreign sources paid to domestic residents minus income from domestic sources paid to foreign residents. GNP = GDP + NT

Current Account Current Account is Net Current funds earned overseas. Income may be earned overseas through producing goods domestically and selling goods abroad or playing a hand in producing goods overseas (as a worker, entrepreneur, or capitalist). Current Account is NX + NT ≡ CA

Worsening Current Account

National Savings Savings = private sector savings + public sector savings. Define TAX = Net Taxes = Tax Revenues less transfer payments (social welfare, etc.). Real Public Savings = T – G ≡ S G Private Sector Savings is Disposable Income minus Consumption Real Private Saving = Q +NT – T – C = S P

Savings Private Savings can occur through household saving or business saving Household savings occur when households earn income (as wages, interest or dividends) that they do not consume. Business Investment occurs when firms keep profits instead of paying them as dividends. Prevalence of two types of savings depends on importance of equity finance in the financial system. Business savings is a bigger source of funds in NA than Europe or Asia.

Capital & Financial Account There are two ways to finance domestic investment Capital & Financial Account represents net capital inflows which finance domestic investment net of savings. Real Capital & Financial Account = I - S

C & FAccount = -Current Account As an accounting identity, I – S = I – (S G + S P ) = I – (T – G + Q +NT – C – T) = C + I + G – Q – NT = -NX - NT Intuitively, if you earn more income overseas than you pay out, you can acquire foreign assets.

Capital Account Capital & Financial Account includes both Capital Account (direct transfers of capital, often through debt forgiveness or default) and Financial Account which represents acquisition or Sale of Financial assets. Financial Account divided into 5 categories 1. Reserve Asset – Official holdings of foreign reserves 2. Bank Lending 3. Portfolio Investment – Stocks & Bonds 4. Direct Investmnet- Ownership stakes in equity 5. Other