Slides for International Finance Macroeconomic Accounting (KO Chapter 12)

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1 Macroeconomic Accounting (KO Chapter 12) American University

2 Preview and Product Accounts National income accounts Measure national income and value of production Measure value of expenditures consumption (C) investment (I) government expenditure (G) current account (CA) Balance of payments accounts Record transactions with foreign residents

3 Accounts Record the value of national income that results from production and expenditure. National income is often defined to be the income earned by a nation s factors of production. Producers earn income by selling goods and services to buyers. Expenditure by buyers = income for sellers (= the value of production).

4 Gross national product (GNP) GNP is the value of all final goods and services produced by a nation s factors 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 factors of production are counted as US GNP.

5 Calculating GNP and Product Accounts GNP is calculated by adding the value of expenditure on final goods and services produced. Types of expenditure: Consumption: expenditure by domestic consumers Investment: expenditure by firms on buildings & equipment Government purchases: expenditure by governments on goods and services Current account balance (exports minus imports): net expenditure by foreigners on domestic goods and services

6 GNP = Expenditure and Product Accounts Y = C d + I d + G d + EX = (C C f ) + (I I f ) + (G G f ) + EX = C + I + G + EX (C f + I f + G f ) = C + I + G + EX IM = C + I + G + CA (1) GNP = absorption + current account

7 and Product Accounts A more precise measure of national income is GNP adjusted for following: Depreciation of physical capital results in a loss of income to capital owners, so the amount of depreciation is subtracted from GNP. Unilateral transfers to and from other countries can change national income: payments of expatriate workers sent to their home countries, foreign aid and pension payments sent to expatriate retirees

8 GDP and national income (US, 2009, billions) Gross national product... 14,265.3 Less: Consumption of fixed capital... 1,861.1 Less: Statistical discrepancy Equals: National income... 12,225.0 Q: What is missing from this concept? A: Net unilateral transfers received from abroad (UTr). Source: /txt/gdp2q10_adv.txt

9 Gross Domestic Product (GDP) If we subtract from GNP the net factor payments from abroad (FP) we get 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 production Gross domestic product measures the final value of all goods and services that are produced domestically (i.e., within a country) in a given time period.

10 GNP and GDP in the Philippines in 2005 (PHP millions at constant 1985 prices) Personal Consumption Expenditure 947,799 Government Consumption 76,465 Capital Formation 225,601 Exports 541,982 Imports 630,181 Statistical Discrepancy 42,866 GDP 1,204,533 Net Factor Income from abroad 101,002 GNP 1,305,535 Most of net factor income is measured as remittances from overseas Filipino workers (OFWs), and is often referred to as OFW remittances. Source: http: //dirp3.pids.gov.ph/ris/eid/pidseid0606.pdf

11 (US, 2009, billions) Gross domestic product... 14,119.0 Plus: Income receipts from the rest of the world Less: Income payments to the rest of the world Equals: Gross national product... 14,265.3 Source: /txt/gdp2q10_adv.txt

12 GDP Components (US, 2009, billions of dollars) Gross domestic product (GDP)... 14,119.0 Personal consumption expenditures... 10,001.3 Goods... 3,230.7 Durable goods... 1,026.5 Nondurable goods... 2,204.2 Services... 6,770.6 Source: /txt/gdp2q10_adv.txt

13 GDP Components (US, 2009, billions of dollars) Gross private domestic investment... 1,589.2 Fixed investment... 1,716.4 Nonresidential... 1,364.4 Structures Equipment and software Residential Change in private inventories

14 GDP Components (US, 2009, billions of dollars) Net exports of goods and services Exports... 1,578.4 Goods... 1,063.1 Services Imports... 1,964.7 Goods... 1,587.8 Services

15 GDP Components (US, 2009, billions of dollars) Government consumption expenditures and gross investment... 2,914.9 Federal... 1,139.6 National defense Nondefense State and local... 1,775.3 Source: /txt/gdp2q10_adv.txt

16 Components of US GDP

17 Components of US GDP (as pct)

18 National saving (S) and Product Accounts National saving (S) = national income (Y) that is not spent on consumption (C) or government purchases (G). S = Y - C - G S = (Y - C - T) + (T - G) S = S^p + S^g

19 National Saving and the Absorption approach: CA = Y - (C + I + G ) Current account surplus spending < less than national income we must be lending abroad (on net) This implies a financial capital outflow or positive net foreign investment. Current account deficit spending > national income we must be borrowing abroad (on net) This implies a financial capital inflow or negative net foreign investment.

20 National Saving and the current account = net foreign investment Rewrite this as CA = (Y C G) I = S I (2) current account = national saving - investment A country that imports more than it exports has low national saving relative to investment.

21 CA and NFA and Product Accounts CA = EX IM = Y (C + I + G) (3) When production > domestic expenditure, exports imports: current account >0. 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. A country exports less than it imports, it earns less income from exports than it spends on imports net foreign wealth is decreasing

22 and Product Accounts BOPBCA?cid=125

23 U.S. (CA/GDP)

24 U.K. (CA/GDP) Source: United Kingdom Balance of Payments - The Pink Book

25 Euro Area (%GDP) Source: ECB

26 U.S. Exports and Imports Source: transactions/2010/pdf/trans110.pdf

27 U.S.: CA and NFA and Product Accounts Source: Krugman and Obstfeld (fig 12.2)

28 Investment Finance and Product Accounts Countries can finance investment either by saving or by acquiring foreign funds equal to the current account deficit. Recall CA = S - I When S > I, then CA > 0 so that net foreign investment and financial capital outflows for the domestic economy are positive. I = S - CA

29 Twin Deficits and Product Accounts 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 current account balance when other factors remain constant.

30 Twin Deficits vs. Ricardian Equivalence Late 1990s: EU governments slashed deficits from 5.4% to 0.8% of GDP. (Required to participate in January 1999 launch of euro.) The current account for EU countries was little changed. Why? Private saving decreased by about the same amount! Explanations: Household wealth increases. Financial wealth rose in this period. Ricardian equivalence.

31 No Twin Deficits in EU (%GDP) Year CA Sp I G-T

32 Net International Investment Position Net International Investment Position (NIIP) foreign assets - foreign liabilities NIIP is affected by capital gains and losses: changes in asset prices in own currency exchange rate changes -> changes in domestic price

33 CA vs. Change in NIIP CA and NIIP (US, $billions) NIIP 2009 (eop) -2,738 NIIP 2008 (eop) -3,494 Delta NIIP 756 CA 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

34 Net International Investment Position (NIIP) Foreign assets held by the US have grown since 1980, but US liabilities (our debt held by foreigners) have grown more quickly. The US current account in 2009 was -$378B: US net foreign wealth continued to decrease. The US has the most negative net foreign wealth in the world, and so is therefore the world s largest debtor nation. By the end of 2009, the US international investment position was -$2.74T.

35 U.S.: NIIP and Product Accounts Data Source: BEA

36 Investment Income and Product Accounts 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 much higher rate of return. Portfolio composition: our accumulated net FDI position is very positive.

37 Income Account: Payments and Receipts Data Source: BEA

38 U.S. CA Components Source: transactions/2010/pdf/trans110.pdf

39 Net International Investment Position NIIP was measured at historical value until original purchase price BEA now uses two different measures affected by capital gains and losses current cost cost today of same direct investment market value price at which assets could be sold

40 Net International Investment Position Both assets and liabilities have grown over time foreign assets = 25% of GDP foreign liabilities = 16% of GDP foreign assets = 104% of GDP foreign liabilities = 123% of GDP

41 Net International Investment Position 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

42 Balance of Payments Accounts Balance of Payments Accounts A country s balance of payments accounts record its payments to and its receipts from foreigners. An international transaction involves two parties. Each transaction enters the accounts twice: once as a credit (+) and once as a debit (-). Credit (+): outflow of value Debit (-): inflow of value

43 Balance of Payments Accounts Financial Flows Financial inflow: Foreigners loan to domestic citizens by buying domestic assets Domestic assets sold to foreigners are a credit (+) because the domestic economy acquires money during the transaction Financial outflow: Domestic citizens loan to foreigners by buying foreign assets Foreign assets purchased by domestic citizens are a debit (-) because the domestic economy gives up money during the transaction.

44 Balance of Payments Accounts Balance of Payments: The Accounts The balance of payments accounts are separated into 3 broad accounts: current account: records flows of goods and services (imports and exports). financial account: records flows of financial assets (financial capital). capital account: records flows of special categories of assets (capital): typically non-market, non-produced, or intangible assets like debt forgiveness, copyrights and trademarks.

45 Balance of Payments Accounts World Trade Volume World Exports Relative to GDP, 2000 = 100 Source: e/pr598_e.htm

46 Balance of Payments Accounts BoP Accounts Always Balance Due to the double entry of each transaction these three accounts must sum to zero. current account + financial account + capital account = 0 (In reality we include a statistical discrepancy due to recording problems.)

47 Balance of Payments Accounts BoP Sub Accounts: CURRENT ACCOUNT Merchandise Trade Services tourism transportation business, professional and other services Income (Factor Services) Investment Income Employee Compensation Unilateral Current Transfers (incl. workers remittances) government grants government pensions private remittances and other transfers (including taxes)

48 Balance of Payments Accounts BoP Sub Accounts: CAPITAL AND FINANCIAL ACCOUNT Capital Account Unilateral Capital Transfers (debt forgiveness, investment grants) Acquisition/Disposal of IPRs Financial Account (Private) Direct Foreign Investment Portfolio Investment (long term and short term) Financial Account (ORT) (gold, IMF credits and SDRs, foreign exchange reserves) Changes in domestic assets held by foreign monetary authority Changes in foreign assets held by domestic monetary authority Statistical Discrepancy (reported in Financial Account)

49 Balance of Payments Accounts Official Settlements Balance Official Settlements Balance = -ORT Sometimes called the balance of payments.

50 Balance of Payments Accounts 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 bank account in San Francisco. The bank credits the account by the amount of the deposit. Account Amount -$30 Financial Account +$30

51 Balance of Payments Accounts BoP Example: Securities You invest in the Japanese securities market by buying $5000 in Sony bonds. 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) -$5000 Financial Account (deposit ownership) +$5000

52 Balance of Payments Accounts 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 that value 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 Capital account. Account Capital Account (debt forgiveness) Financial Account (deposit ownership) Amount -$20M +$20M

53 Balance of Payments Accounts References See the syllabus.

Chapter 13: National Income Accounting and the Balance of Payments

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