Chapter 12

National Income Accounting and

the Balance of Payments
GNP = Expenditure on a Country’s
Goods and Services
expenditure
Y = C + I + G + EX
National d d d
on production
income =
value of
production
= (C-Cf) + (I-If) + (G-Gf) + EX
= C + I + G + EX – (Cf + If +Gf)
= C + I + G + EX – IM
= C + I + G + CA

Domestic Net expenditure

expenditure by foreigners
Fig. 12-1: U.S. GNP and Its Components

Source: U.S. Department of Commerce, Bureau of Economic

Analysis
12-3
 Imports and Exports
As a Fraction of GDP
50%
45%
40%
Percentage of GDP

35%
30%
25%
20%
15%
10%
5%
0%
Canada France Germany Italy Japan Mexico UK US

imports exports

Imports and exports as a percentage of GDP by country, 2000. Source: OECD

 GNP and GDP
• Gross domestic product measures the
final value of all goods and services that are
produced within a country in a given
time period.
• GNP = GDP + factor payments from
foreign countries - factor payments to
foreign countries
• GNP = GDP + net factor income from abroad
 Expenditure and Production
in an Open Economy
CA = EX – IM = Y – (C + I + G )
• When production > domestic expenditure, exports >
imports: current account > 0, trade balance > 0
– when a country exports more than it imports, it earns more
income from exports than it spends on imports
– net foreign wealth is increasing

• When production < domestic expenditure, exports <

imports: current account < 0, trade balance < 0
– when a country exports less than it imports, it earns less income
from exports than it spends on imports
– net foreign wealth is decreasing
 US Current Account
as a Percentage of GDP, 1960–2004

2%
1%
s ul pr us

0%
-1 %1 96 0 19 65 1 97 0 19 7 5 1 9 80 1 98 5 19 9 0 1 9 95 2 00 0

-2 %
-3 %
-4 %
ti ci f ed

-5 %
-6 %
yea r
S o u rce: B u reau o f E co n o m ic A n alysis, U S D ep artm en t o f C o m m erce
Fig. 12-2: U.S. Current Account and
Net Foreign Wealth, 1976–2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007 release
12-8
Fig. 12-3: U.S. Gross Foreign Assets and
Liabilities, 1976-2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007

12-9
 U.S. Current Account
and Net Foreign Wealth
CA NIIP
• 2006: • 2006
CA = -$788 billion – NIIP = -$2,226 billion
(6.0% of GDP)
GDP = $11,178 billion • 2007
– NIIP = -$2,442 billion
• 2007:
CA = -$731 billion – Why did the US NIIP
(5.3% of GDP) change by (-)$216 billion
GDP = $13,875 billion instead of (-)$731 billion?
Saving and the Current Account
• National saving (S) = national income (Y) that is
not spent on consumption (C) or government
purchases (G).

Y–C–G
= (Y – C – T) + (T – G)

⇒ S = Sp + Sg
• National saving = private saving + govt saving
 How Is the Current Account
Related to National Saving?
CA = Y – (C + I + G )
⇒ CA = (Y – C – G ) – I
CA = S – I
current account = national saving – investment
current account = net foreign investment
Note: I is domestic investment

• A country that exports more than it imports

invests in foreign countries (by lending the CA
surplus to foreigners).
 How Is the Current Account
Related to National Saving? (cont.)
CA = S – I or I = S – CA
• Countries can finance investment either by
saving or by acquiring foreign funds equal
to the current account deficit.
– a current account deficit or negative net
foreign investment implies a financial capital
inflow (through international borrowing).
 How Is the Current Account
Related to National Saving? (cont.)
CA = Sp + Sg – I
= Sp – GD – I

• GD, Government deficit (= G – T), is negative

govt saving
• A high government deficit causes a negative
current account balance, all other things equal.
 Inverse Relationship Between
Public Saving and Current
U S c u r r e nAccount?
t a c c o u n t a n d p u b l i c s a v i n g r e l a t iv e t o G D P ,
1 9 6 0 -2 0 0 4
4%
2%
0%
Percent of GDP

-2 %
-4 %
-6 %
-8 %
1960 1965 1970 1975 1980 1985 1990 1995 2000

c u r re n t a c c o upnut b lic s a v in g

Source: Congressional Budget Office, US Department of Commerce

 Balance of Payments Accounts
• A country’s balance of payments accounts
record its payments to and its receipts from
foreigners.
• Record all international transactions in goods,
services, assets
Services: travel, transportation, royalties, etc.
Assets: bank loans, deposits, stocks, bonds, etc.
Table 12-2: U.S. Balance of Payments
Accounts for 2006 (billions of dollars)

12-17
 Table 12-2: U.S. Balance of Payments
Accounts for 2006 (billions of dollars, cont.)

12-18
 3 Broad Accounts
• The balance of payment accounts are separated
into 3 broad accounts:
– current account: accounts for flows of goods and
services (imports and exports).
– financial account: accounts for flows of financial
assets (financial capital).
– capital account: flows of special categories of
assets (capital), typically non-market, non-produced,
or intangible assets like debt forgiveness, copyrights
and trademarks.
 Credit and Debit
• Double-entry bookkeeping: Each international
transaction enters the BoP accounts twice: once
as a credit (+) and once as a debit (-).
• Credit: sale of domestic goods, services, assets
to foreigners
• Debit: purchase of foreign goods, services,
assets from foreigners
 Some useful tips
• Credit: we sell to foreigners
• Debit: we buy from foreigners
• Treat payment as if we sell the financial assets
(e.g., deposits). Receipts are treated as if our
purchase of financial assets.
• The payment part is recorded on the other side
of the BoP table.
• Exceptions: unilateral transfers, debt forgiveness
 Example 1
• 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 –$30

(current account)

Credit (“sale”) of bank account by bank +$30

(financial account)
 Example 2
• 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 –$500

(financial account)
Credit (“sale”) of bank account by bank +$500
(financial account)
 Example 3
• 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 –$100 M

(capital account)

Credit (“sale”) of bank account by bank +$100 M

(financial account)
 More Terms
• Private financial transactions include direct
investment, portfolio investment (security
purchases), and bank claims and liabilities.
• Financial transactions are also classified either
short-term or long-term. Long-term means
maturity longer than or equal to 1 year.
• “Official” means assets treated as foreign
reserves. They include foreign currencies, gold,
Special Drawing Rights, and reserve position at
the IMF.
• Balance of payments = current a/c + capital a/c
+ non-reserve financial a/c
 Capital inflow and outflow
• Financial (capital) inflow
– Foreigners loan to domestic citizens by acquiring
domestic assets.
– This is a credit (+) transaction in the financial account.
– A surplus on the financial account implies net inflow of
foreign capital.
• Financial (capital) outflow
– Domestic citizens loan to foreigners by acquiring
foreign assets.
– This is a debit (-) transaction in the financial account.
– A deficit on the financial account implies net outflow of
foreign capital.
 Current account
• Current account surplus (deficit) implies
that the country lent to (borrowed from)
the ROW in the given year.
 Balance of payments
• Surplus: increase in official reserve assets
• Deficit: decrease in official reserve assets

• Discuss
– Problems of continuing BoP deficits
– Undesirable effects of BoP surpluses
 Example
• CA = -$700 billion
• FA = +$500 billion (nonreserve portion)
• BP = ( )

• Explain in words what international

transactions occurred in this country.