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Chapter 12
Supplementary Notes
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GNP = Expenditure on a Country’s Goods and Services
Y = Cd + Id + Gd + EX
= (C-Cf) + (I-If) + (G-Gf) + EX
= C + I + G + EX – (Cf + If +Gf)
= C + I + G + EX – IM
= C + I + G + CA
Domestic expenditure
Net expenditureby foreigners
expenditureon production
National income = value ofproduction
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National Income Accounts: GNP (cont.)
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Imports and Exports As a Fraction of GDP
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Canada France Germany Italy Japan Mexico UK US
Per
cen
tag
e o
f G
DP
imports exports
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Canada France Germany Italy Japan Mexico UK US
Per
cen
tag
e o
f G
DP
imports exports
Imports and exports as a percentage of GDP by country, 2000. Source: OECD
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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
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Expenditure and Productionin 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
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US Current Account As a Percentage
of GDP, 1960–2004
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
1960 1965 1970 1975 1980 1985 1990 1995 2000
year
Source: Bureau of Economic Analysis, US Department of Commerce
defic
itsu
rplu
s
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US Current Account, 1960–2004
-700
-600
-500
-400
-300
-200
-100
0
100
1960 1965 1970 1975 1980 1985 1990 1995 2000
year
bill
ions
of
curr
ent
doll
ars
Source: Bureau of Economic Analysis, US Department of Commerce
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US Current Account and Net Foreign Wealth, 1977–2003
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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
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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 – investmentcurrent 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).
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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).
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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.
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Inverse Relationship Between Public Saving and Current
Account?
Source: Congressional Budget Office, US Department of Commerce
US current account and public saving relative to GDP, 1960-2004
-8%
-6%
-4%
-2%
0%
2%
4%
1960 1965 1970 1975 1980 1985 1990 1995 2000
Perc
ent o
f GDP
current account public saving
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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.
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US Balance of Payments Accounts, 2003 in Billions of Dollars
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US Balance of Payments Accounts, 2003 in Billions of Dollars (cont.)
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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.
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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
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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
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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(current account)
–$30
Credit (“sale”) of bank account by bank (financial account)
+$30
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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 (financial account)
–$500
Credit (“sale”) of bank account by bank(financial account)
+$500
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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(capital account)
–$100 M
Credit (“sale”) of bank account by bank (financial account)
+$100 M
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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
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Capital inflow and outflow
• Financial (capital) inflow – Foreigners loan to domestic citizens by acquiring domestic
assets. – Foreign owned (sold) assets in the domestic economy are a
credit (+) – A surplus on the financial account implies net inflow of foreign
capital.• Financial (capital) outflow
– Domestic citizens loan to foreigners by acquiring foreign assets. – Domestically owned (purchased) assets in foreign economies
are a debit (-)– A deficit on the financial account implies net outflow of foreign
capital.