Chapter 12

1. Chapter 12 Supplementary Notes

2. expenditure on production Net expenditure by foreigners Domestic expenditure 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 National income = value of production

3. National Income Accounts: GNP (cont.)

4. Imports and Exports As a Fraction of GDP Imports and exports as a percentage of GDP by country, 2000. Source: OECD

5. 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

6. 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

7. surplus deficit US Current Account As a Percentage of GDP, 1960–2004

8. US Current Account, 1960–2004

9. US Current Account and Net Foreign Wealth, 1977–2003

10. 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

11. 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 – investment current 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).

12. 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).

13. 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.

14. Inverse Relationship Between Public Saving and Current Account? Source: Congressional Budget Office, US Department of Commerce

15. 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.

16. US Balance of Payments Accounts, 2003 in Billions of Dollars

17. US Balance of Payments Accounts, 2003 in Billions of Dollars (cont.)

18. 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.

19. 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

20. 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

21. 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.

22. 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.

23. 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.

24. 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

25. 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.