The National Income Accounts Gross national product (GNP)

• The market value of all final goods and services produced by a country’s factors of production in a year, whether in the country or abroad.

Y = C + I + G + EX – IM

Y = C + I + G + CA

National Income Accounting for an Open Economy

Consumption (C)

•The portion of GNP purchased by the private sector to fulfill current wants

Investment (I)

•The part of output used by private firms to produce future output

Government Purchases (G)

•Any goods and services purchased by federal, state, or local governments

Current Account (CA = “EX – IM”)

•Goods and services, including factor service, purchased by foreigners net of foreign g&s purchased by residents

The National Income AccountsU.S. GNP and Its Components, 2006

For purposes of macro analysis,

GNP = Y = NI

Gross Domestic Product (GDP) measures the volume of production within a country’s borders.• GDP equals GNP minus net factor income from the rest of the

world. Income earned from production abroad doesn’t count in gross domestic product.

GDP = GNP – Income earned abroad

The National Income Accounts

National Income•Earned over a period by a nation’s factors of production.

NI = GNP – Depreciation – IBT + Unilateral Transfers

The Current Account and Foreign Indebtedness

• Current account (CA) balance: CA = EX – IM CA measures the size and direction of international borrowing.

• If we import more than we export (CA<0), we must pay for the difference by borrowing from foreigners.

CA equals the change in a country’s net foreign wealth. CA balance is equal to the difference between national income

and domestic residents’ spending or absorption:

Y – (C+ I + G) = CA CA balance is what we produce (Y) less domestic demand.

• We can live “beyond our means” if we run a current account deficit, import more than we export, and borrow the difference from foreigners.

CA balance is the excess supply of domestic financing. • If we produce and earn more than domestic demand (CA>0), we

lend our “excess” saving to foreigners

U.S. Current Account and Net Foreign Wealth, 1976–2006

Saving and the Current Account• National saving (S) : The portion of output, Y, that is not

devoted to household consumption, C, or government purchases, G.

S = I in a closed economy.• A closed economy can save only by building up its capital stock • An open economy can save either by building up its capital stock

or by acquiring foreign wealth

S = I + CA

• A country’s CA surplus is its net foreign investment:

CA = NFI = Capital Outflows- CA = Capital Inflows

International Monetary Arithmetic Sources of Income = Uses of Income

C + I + G + CA = T + Sp + C

I = Sp + (T – G) – CA = Nat’l Saving+Capital Inflows Domestic investment is financed by our own saving plus

our net “borrowing” from foreigners

Nat’l Borrowing = - CA = (I - Sp) + (G – T) The Twin Deficits

Private Saving (Sp ) and Government Saving (Sg )

Sp = Y – T – C = I + CA – (T – G) = I + CA – Sg Sp = I + CA + (G – T)

Private saving finances domestic investment, net foreign investment, and the government’s deficit

Three types of international transactions

• Payments for exports or imports of goods or services, including factor services

Current Account

• Purchases or sales of financial assets

Financial Account

• Transfers of wealth between countries Capital Account

The Fundamental Balance of Payments Identity

Current account + financial account + capital account = 0

The Balance of Payments Accounts

U.S. Balance of Payments Accounts for 2006 (billions of dollars)

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U.S. Balance of Payments Accounts for 2006 (billions of dollars, cont.)

Financial account has at least 3 subcategories:

Official (international) reserve assets

Foreign assets are held by central banks as a cushion against national economic misfortune. Central banks often buy or sell international reserves in private asset markets to affect macroeconomic conditions in their economies.

Official reserve assets include government bonds, currency, gold and accounts at the International Monetary Fund.

All other assets Statistical discrepancy The negative value of the official reserve assets is called the official

settlements balance or “balance of payments.” A country with a negative balance of payments is running down its reserve assets or incurring debts to foreign monetary authorities. In 2006, the Fed & Treasury reduced its holdings of foreign assets by $2.4

billion and foreign central banks and government agencies increased their holdings of US assets by $440.3 billion. The $442.7 net inflow

US Balance of Payments Deficit = $442.7 billion

U.S. Current Account and Net Foreign Wealth, 1976–2006

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International Investment Position of the United States at Year End, 2005 and 2006 (millions of dollars)

International Investment Position of the United States at Year End, 2005 and 2006 (millions of dollars)

Problems, Chapter 1212.6 Why might a government be concerned about a large CA deficit or

surplus? Why might it be concerned about a large surplus or deficit in its official settlements account (i.e., its “balance of payments”)?

12.8 Can a country have a CA deficit at the same time it has a BoP surplus? Explain using hypothetical figures for the CA and the nonreserve financial account. Discuss implications for official international reserve flows.

12.10 In 2006, US income receipts on foreign assets were $647.6 billion while payments on liabilities (foreign owned assets in the US) were $604.4 billion. Yet the US is a substantial net debtor to foreigners. How then is it possible that the US received more foreign income than it paid out?