Section 1

The Balance of Payments

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 Content
Objectives
The National Income Accounts
S, I, and CA
The BOP Accounts
Bookkeeping
Summary

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 Objectives
To review national income accounting
The national income accounts record all the
income and expenditures of a country.
To review balance of payments accounting
The balance of payments accounts record all
international transactions of a country.

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 The National Income Accounts
Gross National Product (GNP)
The value of all final goods and services
produced by a countrys factors of production
and sold on the market in a given time period.
The Output of a country in a given time period.

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 The National Income Accounts
Gross Domestic Product (GDP)
The value of all final goods and services
produced by the factors of production within a
countrys borders.
GDP = GNP - net receipts of factor income
from the rest of the world.

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 The National Income Accounts
The National Income Identity
Y = C + I + G + EX IM
where:
Y is GNP
C is consumption
I is investment
G is government purchases
EX is exports
IM is imports

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 The National Income Accounts
Consumption (C)
The share of GNP consumed by the private sector.
Investment (I)
The share of GNP used by private firms to produce
future output.
Government Purchases (G)
The share of GNP used by federal, state, or local
governments

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 The National Income Accounts
Exports (EX)
The share of GNP exported to the rest of the
world.
Imports (IM)
The share of GNP imported from the rest of
the world.

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 The National Income Accounts
The Current Account (CA)
CA = EX IM
A country has a CA surplus when its CA > 0.
A country has a CA deficit when its CA < 0.
CA measures the size and direction of international
borrowing.
A countrys current account balance equals the change
in its net foreign wealth.

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Figure 12-1: U.S. GNP and Its Components, 2000

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Figure 12-2: The U.S. Current Account and Net Foreign
Wealth Position, 1977-2000

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 US Current Account and Trade Balance
(as a share of GDP)

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.

Note: The vertical bars indicate periods of recession as defined by the National Bureau of Economic
Research
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 S, I, and CA
National Savings (S)
The share of GNP that is not devoted to household
consumption or government purchases.
S=YCG
S = PS + GS

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 S, I, and CA
Private Savings (PS)
The share of disposable income saved.
PS = Y T C
Government Savings
The share of tax revenues (T) saved.
GS = T G
Government budget deficit: G T

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 S, I, and CA
The key relation: I = S CA
S = PS + GS
PS = Y T C
GS = T G
CA = EX IM
Y = C + I + G + EX - IM

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 S, I, and CA
The current account is a measure of foreign
savings at home.
Are current account deficits good?
The twin deficits hypothesis.

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 The BOP Accounts
The Balance of Payments (BOP) accounts is
a record of all transactions between a
country and the rest of the world.
Every transaction enters the BOP twice:
once as a credit (+) and once as a debit (-).

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 The BOP Accounts
The Current Account (CA)
The current account divides exports and
imports into three categories:
Merchandise trade
Services
Interest and dividend income

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 The BOP Accounts
The Capital and Financial Account (KA)
The capital and financial account records the
exports and imports of assets.
Capital inflow: An export of assets.
Capital outflow: An import of assets.

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 The BOP Accounts
Official Reserve Transactions (RFX)
Official international reserves
Foreign assets held by central banks.
Official foreign exchange intervention
Exchange rate intervention often requires to alter
the amount of official reserves.

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 The BOP Accounts
The key relation: CA + KA = RFX
This is an accounting identity
Accounting:
Exports are recorded as credits (+) in CA, KA
Imports are recorded as debits (-) in CA, KA

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 Bookkeeping
Example 1:A U.S. citizen buys a $1000 typewriter from
an Italian company, and the Italian company deposits the
$1000 in its account at Citibank in New York.
Entries in the U.S. balance of payments:
Purchases (imports) typewriter: Debit CA of $1000.
Sells (exports) asset: Credit to KA of $1000.
CA (-$1000) + KA (+$1000) = 0

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 Bookkeeping
Example 2: A U.S. citizen buys a $95 newly issued share
of stock in the United Kingdom oil giant British Petroleum
(BP) by using a check drawn on his stockbroker money
market account. BP deposits the $95 in its own U.S. bank
account at Second Bank of Chicago.
Entries in the U.S. balance of payments:
Purchases (imports) share: Debit to KA of $95.
Sells (exports) assets: Credit to KA of $95.
CA ($0) + KA (+$95 -$95) = 0

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 Bookkeeping
A reduction of official reserves: RFX < 0
An export of assets by the central bank.
An increase of official reserves: RFX > 0
An import of assets by the central bank.
So, changes in RFX similar to transactions
in KA.

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 Summary
GNP measures the income and production
of a countrys factors of production.
GDP measures the output produced within a
countrys territorial borders.
Y = C + I + G + EX IM
I = PS + GS CA
The current account is a measure of the
countrys net lending to foreigners.
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 Summary
The current account records net exports of
goods and services.
The capital and financial accounts record
net exports of assets.
BOP = CA + KA = RFX
Exports are recorded as a credit.
Imports are recorded as a debit.
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