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Chapter 16 National and International Accounts: Income, Wealth, and the Balance of Payments

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Title: Chapter 16 National and International Accounts: Income, Wealth, and the Balance of Payments


1
Chapter 16 National and International Accounts
Income, Wealth, and the Balance of Payments
  • National Accounts Product, Expenditure, and
    Income
  • Balance of Payments Accounts
  • External Wealth

2
National Accounts Product, Expenditure, and
Income
Our focus in this chapter is the international
system of trade and payments. The key organizing
principle is that international trade in goods
and services is complemented by a parallel trade
in assets. This happens all the time in everyday
life, but we need to know what are the
implications of this asset trade when
transactions take place across an international
border.
3
National Accounts Product, Expenditure, and
Income
But first, we need to understand that
international transactions are a part of the
larger pattern of aggregate economic activity
within a nation. This activity is summarized in
the National Income and Product Account (NIPA) of
countries. As it turns out, there are a few ways
to measure aggregate economic activity
4
National Accounts Product, Expenditure, and
Income
A natural question might be, why all the
different approaches? There are a few reasons
methodological (what is the true level of
aggregate economic output) and practical (what is
the best way to actually measure
aggregate economic output). But our focus is
more on how these various approaches (product,
income, and expenditure) and their measures (GNE,
GDP, and GNI) relate to one another.
5
National Accounts Product, Expenditure, and
Income
The expenditure approach looks at the demand for
goods. It examines how much is spent on demand
for final goods and services by households,
businesses, and the government. It is measured
by Gross National Expenditure (GNE) which is just
the sum of all expenditures on final goods and
services in the economy by the three sectors
listed above.
6
National Accounts Product, Expenditure, and
Income
C personal consumption expenditures total
spending on final goods and services by private
households I gross private domestic investment
total spending on final goods and services by
firms or households to make additions to the
stock of capital G government consumption
expenditures and gross investment total
spending on final goods and
7
National Accounts Product, Expenditure, and
Income
8
National Accounts Product, Expenditure, and
Income
The product approach looks at the supply of
goods. It examines how much goods and services
are produced by firms in the economy. It is
measured by Gross Domestic Product (GDP) which is
the value of all final goods and services minus
the value of all the intermediate goods purchased
by firms.
9
National Accounts Product, Expenditure, and
Income
Why do we care about value added? Suppose
Petro Canada buys 100 M of crude oil from BP
Canada to refine into 200 M worth of gas. In
this case, GDP accounting would measure up
an increase in domestic value added of 100M.
That is, 200M of final goods and services sold
less 100M for intermediate inputs.
10
National Accounts Product, Expenditure, and
Income
If we used gross receipts as our measure of
economic activity, we would double count a lot of
economic activity. In this case, total sales
would be 300 M, but this is a misleading measure
of economic activitythink about the case where
Petro Canada buys BP Canada and this transaction
occurs within the boundaries of the firm.
11
National Accounts Product, Expenditure, and
Income
Up to this point, we have only said that GDP
equals the value added by firms. But we have not
said anything about where that value added ends
up, i.e. whether firms are engaging
in international trade. In a world of
international trade, the total value of
goods sold both domestically and internationally
must equal
12
National Accounts Product, Expenditure, and
Income
In this case, we can define GDP in the
following manner where GDP, C, I, and G are
from before and IM imported goods sold by the
rest of the world EX exported goods purchased
by the rest of the world
13
National Accounts Product, Expenditure, and
Income
Rearranging, where GNE is from before
and TB the trade balance or net exports
14
National Accounts Product, Expenditure, and
Income
15
National Accounts Product, Expenditure, and
Income
Finally, the income approach looks at payments to
the factors of production. It examines the
income of residents, arising from domestically
located economic activity and net income from
overseas. It is measured by Gross National
Income (GNI/GNP) which is the value of
16
National Accounts Product, Expenditure, and
Income
In a closed economy (i.e. no foreign investment
or trade), factor payments by firms would be the
same as the income receipts of factor owners. In
this case, GNI would equal GDP.
17
National Accounts Product, Expenditure, and
Income
But international investment and trade do occur,
giving rise to differences in GNE, GDP, and
GNI. Specifically, in an open economy, we have
to allow for
18
National Accounts Product, Expenditure, and
Income
We might want to ask whether the distinction
between GNI and GDP is a useful one.
19
National Accounts Product, Expenditure, and
Income
A final refinement we need to account for is
non-market transactions. These transactions come
in the form of foreign aid by governments,
private charitable gifts to foreign recipients,
and income remittances by individuals. Gross
national disposable income (GNDI) is simply GNI
corrected for such non-market transactions.
20
National Accounts Product, Expenditure, and
Income
Formally, the net gifts received by a country are
called net unilateral transfers (NUT). Gross
national disposable income (GNDI) is given
by Y from now on is our preferred measure of
national income (Y) as it most closely
corresponds to the
21
National Accounts Product, Expenditure, and
Income

22
National Accounts Product, Expenditure, and
Income
As we said before, in a closed economy,
YGNIGDPGNE, but the existence of
international transactions drives them apart. In
the equation, all the stuff to the right of
GNE is collectively known as the current account,
CA. So, Y GNE CA. Why is this important? A
current account surplus
23
National Accounts Product, Expenditure, and
Income
24
National Accounts Product, Expenditure, and
Income
What the current account tells us First, lets
define national saving. National saving (S)
national income (Y) that is not spent on
consumption (C) or government purchases (G).
25
National Accounts Product, Expenditure, and
Income
Second, the national income identity is given
by When SgtI, a country is running a
current account
26
National Accounts Product, Expenditure, and
Income
Countries can finance investment either by saving
or by acquiring foreign funds equal to the
current account deficit. A current account
deficit (CAlt0) implies a financial capital
inflow
27
National Accounts Product, Expenditure, and
Income
Thus, the current account is equal to net
foreign investment. Because the balance of trade
is the main determinant of the current account,
in general, a country that imports more than it
exports has low national saving relative
to investment. This is what is meant when people
say a country is living beyond their means
28
National Accounts Product, Expenditure, and
Income
Global imbalances
29
National Accounts Product, Expenditure, and
Income
Global imbalances
30
National Accounts Product, Expenditure, and
Income
What are the sources of current account
deficits? One culprit is government deficits
remember CA S I S Private saving plus
public saving A government deficit is negative
public saving. A high government deficit causes
a negative current account balance, all other
things equal.
31
National Accounts Product, Expenditure, and
Income
Twin Deficits
32
National Accounts Product, Expenditure, and
Income
Twin Surpluses?
33
Balance of Payments Accounts
A countrys balance of payments accounts details
its payments to and its receipts from
foreigners. Each international transaction
enters the accounts twice once as a credit ()
and once as a debit (-), so we can think of it
as Finally, the balance of payment accounts are
separated into three broad sub-accounts, one of
which we have seen before, the current account.
34
Balance of Payments Accounts
1.) The current account (CA) accounts for flows
of goods and services (imports and
exports). 2.) The financial account (FA)
accounts for flows of financial assets
(financial capital). 3.) The capital account
(KA) accounts for flows of special categories
of assets (capital), typically non-market,
non-produced, or intangible assets
35
Balance of Payments Accounts
The balance of payments at work 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 Vancouver. The
bank credits the account by the amount of the
deposit. _________________________________________
____ DVD purchase 30 (current
account) -----------------------------------------
-------------------------- Credit (sale) of
bank account by bank 30
36
Balance of Payments Accounts
The balance of payments at work You invest in
the Japanese stock market by buying 5000 in Sony
stock. Sony deposits your funds in its Toronto
bank account. The bank credits the account by the
amount of the deposit. ___________________________
__________________ Purchase of stock
5000 (financial account) -----------------------
-------------------------------------------- Credi
t (sale) of bank account by bank 5000
37
Balance of Payments Accounts
The balance of payments at work Canadian banks
forgive a 100 M debt owed by the government of
Argentina through debt restructuring. Canadian
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
38
Balance of Payments Accounts
By design, the balance of payments (not
surprisingly) always balances. Due to the double
(but oppositely signed) entry of
each transaction, the balance of payments
accounts conform to the following equation CA
FA KA 0 This simply reflects the fact that
the value of items received by the rest of the
world by Canada must equal
39
Balance of Payments Accounts
Each of the three broad sub-accounts are also
more finely divided. The current account (CA)
records imports exports of -merchandise
(goods like DVDs) -services (payments for legal
services, shipping services, tourist
meals,) -income receipts (interest and dividend
payments,
40
Balance of Payments Accounts
The current account (CA) also records net
unilateral transfers (NUT)remember these are
gifts (transfers) across countries that do not
purchase a good or service nor serve as
income. The capital account (KA) records special
asset transfers, Since the first we have
already seen and the second is of minor
importance, our emphasis will here will be on
the financial account (FA).
41
Balance of Payments Accounts
The financial account (FA) measures the
difference Financial (capital) inflow
Foreigners loan to domestic citizens (via trade)
by acquiring domestic assets foreign-owned
(sold) assets in the domestic economy are treated
as a credit (). Financial (capital) outflow
Domestic citizens loan to foreigners by acquiring
foreign assets domestically owned (purchased)
assets in foreign economies are treated as a
debit (-).
42
Balance of Payments Accounts
The financial account (FA) has at least two
categories 1.) Statistical discrepancy (or the
fudge factor) Data from a transaction may come
from different sources that differ in coverage,
accuracy, and timing. The balance of payments
accounts therefore seldom balance in
practice. Statistical discrepancy is the account
added to or subtracted from the financial account
43
Balance of Payments Accounts
The financial account (FA) has at least three
categories 2.) Official (international) reserve
assets These are foreign assets held by central
banks to cushion against instability in
international markets. Assets include foreign
government bonds, foreign currency, gold and
accounts (drawing rights) at the International
Monetary Fund
44
Balance of Payments Accounts
Official reserve assets owned by (sold to)
foreign central banks are treated as a credit
(). Official reserve assets owned by (purchased
by) the domestic central bank are treated as a
debit (-). However, most of the time market
participants will focus in on one key variable
rather than every individual
45
Balance of Payments Accounts
The official settlements balance is the negative
value of the official reserve assets. It is the
sum of the current account, the capital
account, the non-reserve portion of the financial
account, and the statistical discrepancy, so CA
KA (ORA NRA) SD 0 OSB -ORA CA KA
NRA SD
46
Balance of Payments Accounts
Selling foreign currency by the domestic central
bank and buying domestic assets by foreign
central banks are credits for official
international reserve assets, and therefore
reduce the official settlements balance. A
negative official settlements balance may
indicate that a country is depleting its official
international reserve assets or may be incurring
debts to foreign central banks.
47
Balance of Payments Accounts
Putting the BOP accounts of Canada together
48
Balance of Payments Accounts
Putting the BOP accounts of Canada together
49
Balance of Payments Accounts
Putting the BOP accounts of Canada together
50
External Wealth
External wealth is a means of gauging the
financial fortunes of countries relative the rest
of the world. Just like net worth measures the
difference between assets and liabilities for
individual households, external wealth does the
same for entire nations. It is simply the
difference between the assets owned by the home
country in the rest of the world and
51
External Wealth
Although external wealth is a small portion of
aggregate wealth for a country, changes in it may
reflect changes in the relative financial health
of nations. For Canada, external wealth in 2008
stood at a mere 6.7 billion. Maybe not much,
but compare this to the figures for 2006 and
2002 -100 billion and -200 billion CAD.
52
External Wealth
However, the picture changes when
considering developments south of the border. US
external wealth in 2008 stood at nearly -3.5
trillion USD, making it the worlds largest
debtor nation. Even in relative terms (scaling
external wealth by GDP or population), the US has
the most negative net foreign wealth in the
world. And its current account deficit in 2008
was 706 billion
53
External Wealth
And while the value of foreign assets held by the
US has grown since 1980, liabilities of the US
(debt held by foreigners) have grown more quickly.
54
External Wealth
At the other end of this US indebtedness stand
many countries which run persistent trade
surpluses with the United States, e.g. Germany
and Japan. But the big mover here is China with
a net creditor position of 30 of GDP, much of
which is tied to USD denominated assets. One of
the big forces at in the current crisis has been
55
External Wealth
At the same time, about 70 of foreign assets
held by the US are denominated in foreign
currencies and almost all of US liabilities
(debt) are in USD. Changes in the exchange rate,
thus, influence the value of net foreign wealth
(gross foreign assets minus gross foreign
liabilities). A depreciation of the US dollar
(as we see today) makes foreign assets held by
the US more valuable, but
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