slides for international finance - american university · slides for international finance ......

National Income and Product AccountsBalance of Payments Accounting

Slides for International FinanceMacroeconomic Accounting (KO Chapter 12)

Alan G. Isaac

American University

2010-10-03

Alan G. Isaac Slides for International Finance


GDP and GNPNational IncomeCurrent Account

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National income accounts

Measure national income and value of productionMeasure value of expenditures

consumption (C)investment (I)government expenditure (G)current account (CA)

Balance of payments accounts

Record transactions with foreign residents




National Income Accounts

Record the value of national income that results from production andexpenditure.

National income is often defined to be the income earned by anation’s factors of production.

Producers earn income by selling goods and services to buyers.

Expenditure by buyers = income for sellers (= the value ofproduction).




Gross national product (GNP)

GNP is the value of all final goods and services produced by a nation’sfactors of production in a given time period.Factors of production:

land (natural resources)

labor (workers, entrepreneurs)

physical capital (like buildings and equipment).

The value of final goods and services produced by US-owned factorsof production are counted as US GNP.




Calculating GNP

GNP is calculated by adding the value of expenditure on final goodsand services produced.Types of expenditure:

Consumption: expenditure by domestic consumers

Investment: expenditure by firms on buildings & equipment

Government purchases: expenditure by governments on goodsand services

Current account balance (exports minus imports): netexpenditure by foreigners on domestic goods and services




GNP = Expenditure

Y = Cd + Id +Gd +EX

= (C −Cf )+(I − I f )+(G−Gf )+EX

= C + I +G+EX − (Cf + I f +Gf )

= C + I +G+EX − IM

= C + I +G+CA

(1)

GNP = absorption + current account




National Income

A more precise measure of national income is GNP adjusted forfollowing:

Depreciation of physical capital results in a loss of income tocapital owners, so the amount of depreciation is subtracted fromGNP.

Unilateral transfers to and from other countries can changenational income: payments of expatriate workers sent to theirhome countries, foreign aid and pension payments sent toexpatriate retirees




GDP and national income (US, 2009, billions)

Gross national product ....... 14,265.3Less: Consumption of fixed capital... 1,861.1Less: Statistical discrepancy........ 179.1

Equals: National income.............. 12,225.0

Q: What is missing from this concept?A: Net unilateral transfers received from abroad (UTr).Source: http://bea.gov/newsreleases/national/gdp/2010/txt/gdp2q10_adv.txt


http://bea.gov/newsreleases/national/gdp/2010/txt/gdp2q10_adv.txt




Gross Domestic Product (GDP)

If we subtract from GNP the net factor payments from abroad (FP) weget GDP, another approximate measure of national income.

GDP = GNP - FP GNP = GDP + FP

FP = payments from foreign countries for factors of production -payments to foreign countries for factors of productionGross domestic product measures the final value of all goods andservices that are produced domestically (i.e., within a country) in agiven time period.




GNP and GDP in the Philippines

GDP and GNP in 2005 (PHP millions at constant 1985 prices)

Personal Consumption Expenditure 947,799Government Consumption 76,465Capital Formation 225,601Exports 541,982Imports 630,181Statistical Discrepancy 42,866GDP 1,204,533Net Factor Income from abroad 101,002GNP 1,305,535

Most of net factor income is measured as remittances from overseasFilipino workers (OFWs), and is often referred to as OFW remittances.Source: http://dirp3.pids.gov.ph/ris/eid/pidseid0606.pdfAlan G. Isaac Slides for International Finance

http://dirp3.pids.gov.ph/ris/eid/pidseid0606.pdf

http://dirp3.pids.gov.ph/ris/eid/pidseid0606.pdf



GDP and GNP (US, 2009, billions)

Gross domestic product............... 14,119.0

Plus: Income receiptsfrom the rest of the world.......... 629.8Less: Income payments tothe rest of the world............... 483.6

Equals: Gross national product....... 14,265.3

Source: http://bea.gov/newsreleases/national/gdp/2010/txt/gdp2q10_adv.txt






GDP Components (US, 2009, billions of dollars)

Gross domestic product (GDP)....... 14,119.0

Personal consumption expenditures.... 10,001.3Goods.............................. 3,230.7Durable goods.................... 1,026.5Nondurable goods................. 2,204.2

Services........................... 6,770.6








Gross private domestic investment.... 1,589.2Fixed investment................... 1,716.4Nonresidential................... 1,364.4Structures..................... 451.6Equipment and software......... 912.8

Residential...................... 352.1Change in private inventories...... -127.2





Net exports of goods and services.... -386.4Exports............................ 1,578.4Goods............................ 1,063.1Services......................... 515.3

Imports............................ 1,964.7Goods............................ 1,587.8Services......................... 376.9





Government consumption expendituresand gross investment................ 2,914.9Federal............................ 1,139.6National defense................. 771.6Nondefense....................... 368.0

State and local.................... 1,775.3







Components of US GDP




Components of US GDP (as pct)




National saving (S)

National saving (S) = national income (Y) that is not spent onconsumption (C) or government purchases (G).

S = Y - C - GS = (Y - C - T) + (T - G)S = S^p + S^g




National Saving and the Current Account

Absorption approach:

CA = Y - (C + I + G )

Current account surplus spending < less than national incomewe must be lending abroad (on net)This implies a financial capital outflow or positive net foreigninvestment.

Current account deficit spending > national incomewe must be borrowing abroad (on net)This implies a financial capital inflow or negative net foreigninvestment.




National Saving and the Current Account

current account = net foreign investmentRewrite this as

CA = (Y −C −G)− I

= S− I(2)

current account = national saving - investmentA country that imports more than it exports has low national savingrelative to investment.




CA and NFA

CA = EX − IM

= Y − (C + I +G)(3)

When production > domestic expenditure, exports imports: currentaccount >0. A country exports more than it imports, it earns moreincome from exports than it spends on imports net foreign wealth isincreasingWhen production < domestic expenditure, exports < imports: currentaccount <0. A country exports less than it imports, it earns less incomefrom exports than it spends on imports net foreign wealth is decreasing




Current Account

http://research.stlouisfed.org/fred2/series/BOPBCA?cid=125






U.S. Current Account (CA/GDP)




U.K. Current Account (CA/GDP)

Source: United Kingdom Balance of Payments - The Pink Book




Euro Area Current Account (%GDP)

Source: ECB




U.S. Exports and Imports

Source:http://bea.gov/newsreleases/international/transactions/2010/pdf/trans110.pdf


http://bea.gov/newsreleases/international/transactions/2010/pdf/trans110.pdf




U.S.: CA and NFA

Source: Krugman and Obstfeld (fig 12.2)




Investment Finance

Countries can finance investment either by saving or by acquiringforeign funds equal to the current account deficit.Recall

CA = S - I

When S > I, then CA > 0 so that net foreign investment and financialcapital outflows for the domestic economy are positive.

I = S - CA




Twin Deficits

CA = S-I = (S^p + S^g) - I = (S^p - government deficit) - I =(S^p - I) - government deficit

Government deficit is equal to G - T.G-T>0 is negative government saving.A rising government deficit is associated with a declining currentaccount balance when other factors remain constant.




Twin Deficits vs. Ricardian Equivalence

Late 1990s: EU governments slashed deficits from 5.4% to 0.8% ofGDP. (Required to participate in January 1999 launch of euro.)The current account for EU countries was little changed. Why? Privatesaving decreased by about the same amount!Explanations:

Household wealth increases.

Financial wealth rose in this period.

Ricardian equivalence.




No Twin Deficits in EU (%GDP)

Year CA Sp I G-T1995 0.6 25.9 19.9 -5.41996 1.0 24.6 19.3 -4.31997 1.5 13.4 19.4 -2.51998 1.0 22.6 20.0 -1.61999 0.1 21.8 20.8 -0.8




Net International Investment Position

Net International Investment Position (NIIP) foreign assets - foreignliabilities

NIIP is affected by capital gains and losses:

changes in asset prices in own currency

exchange rate changes -> changes in domestic price




CA vs. Change in NIIP

CA and NIIP (US, $billions)

NIIP 2009 (eop) -2,738NIIP 2008 (eop) -3,494Delta NIIP 756CA 2009 -378

Q: How can we have CA<0 and Delta NIIP >0??A: changes in asset prices (as measured in own currency)

capital gains on foreign assets (given E)

depreciation of E




Net International Investment Position (NIIP)

Foreign assets held by the US have grown since 1980, but USliabilities (our debt held by foreigners) have grown more quickly.The US current account in 2009 was -$378B: US net foreign wealthcontinued to decrease.The US has the most negative net foreign wealth in the world, and sois therefore the world’s largest debtor nation.By the end of 2009, the US international investment position was-$2.74T.




U.S.: NIIP

Data Source: BEA




Investment Income

In 2006, the US ran a surplus on Investment Income.

Income receipts were about $650B.

Income payments were about $614B.

How can the US NIIP be so negative, yet we have this surplus?

Mismeasurement of the NIIP? (But still ... !)

Differing rates of return on assets and liabilities.

Relative return: Higgins (2005) argues that our FDI has a muchhigher rate of return.

Portfolio composition: our accumulated net FDI position is verypositive.




Income Account: Payments and Receipts

Data Source: BEA




U.S. CA Components

Source:http://bea.gov/newsreleases/international/transactions/2010/pdf/trans110.pdf







NIIP was measured at “historical value” until 1991.

original purchase price

BEA now uses two different measures affected by capital gains andlosses

current cost cost today of same direct investment

market value price at which assets could be sold





Both assets and liabilities have grown over time

1976

foreign assets = 25% of GDPforeign liabilities = 16% of GDP

2006

foreign assets = 104% of GDPforeign liabilities = 123% of GDP





Large gross positions but denomination differs

liabilities almost all in dollars

assets 70% in foreign currencies

so exchange rate changes -> large change in net dollar position

2006 based example for hypothetical 10% depreciation:

10% x (70% x 104%) = 7.3%

7.3% x GDP = 7.3% x $13.2T = $964B

bigger than CA deficit



Balance of Payments Accounts


A country’s balance of payments accounts record its payments to andits receipts from foreigners.An international transaction involves two parties.Each transaction enters the accounts twice: once as a credit (+) andonce as a debit (-).

Credit (+): outflow of value

Debit (-): inflow of value




Financial Flows

Financial inflow: Foreigners loan to domestic citizens by buyingdomestic assetsDomestic assets sold to foreigners are a credit (+) because thedomestic economy acquires “money” during the transaction

Financial outflow: Domestic citizens loan to foreigners by buyingforeign assetsForeign assets purchased by domestic citizens are a debit (-)because the domestic economy gives up “money” during thetransaction.




Balance of Payments: The Accounts

The balance of payments accounts are separated into 3 broadaccounts:

current account: records flows of goods and services (importsand exports).

financial account: records flows of financial assets (financialcapital).

capital account: records flows of special categories of assets(capital): typically non-market, non-produced, or intangible assetslike debt forgiveness, copyrights and trademarks.




World Trade Volume

World Exports Relative to GDP, 2000 = 100Source: http://www.wto.org/english/news_e/pres10_e/pr598_e.htm


http://www.wto.org/english/news_e/pres10_e/pr598_e.htm

http://www.wto.org/english/news_e/pres10_e/pr598_e.htm



BoP Accounts Always “Balance”

Due to the double entry of each transaction these three accounts mustsum to zero.current account + financial account + capital account = 0(In reality we include a statistical discrepancy due to recordingproblems.)




BoP Sub Accounts: CURRENT ACCOUNT

Merchandise TradeServices

tourismtransportationbusiness, professional and other services

Income (Factor Services)Investment IncomeEmployee Compensation

Unilateral Current Transfers (incl. workers remittances)government grantsgovernment pensionsprivate remittances and other transfers (including taxes)




BoP Sub Accounts: CAPITAL AND FINANCIAL ACCOUNT

Capital AccountUnilateral Capital Transfers (debt forgiveness, investment grants)Acquisition/Disposal of IPRs

Financial Account (Private)Direct Foreign InvestmentPortfolio Investment (long term and short term)

Financial Account (ORT) (gold, IMF credits and SDRs, foreignexchange reserves)

Changes in domestic assets held by foreign monetary authorityChanges in foreign assets held by domestic monetary authority

Statistical Discrepancy (reported in Financial Account)




Official Settlements Balance

Official Settlements Balance = -ORTSometimes called the balance of payments.




BoP Example: Imports

You import a DVD of Japanese anime by using your debit card. (Say,Princess Mononoke by Hiyao Miyazaki.)The Japanese producer of anime deposits the money in its bankaccount in San Francisco.The bank credits the account by the amount of the deposit.

Account Amount

Current Account -$30Financial Account +$30




BoP Example: Securities

You invest in the Japanese securities market by buying $5000 in Sonybonds.You pay with a check that Sony deposits in its NY bank account.The bank credits the account by the amount of the deposit.

Account Amount

Financial Account (bond acquired) -$5000Financial Account (deposit ownership) +$5000




BoP Example: Debt Forgiveness

A US bank forgives a $20M debt owed by the government of Argentina.Here the outflow of value (credit) is evident: forgiveness means thatvalue flows from the US bank to the Argentine government.But what is the other half (debit) side of the transaction?It is handled as an accounting convention and recorded in the Capitalaccount.

Account Amount

Capital Account (debt forgiveness) -$20MFinancial Account (deposit ownership) +$20M




References

See the syllabus.


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