GLOBAL EDITION Macroeconomics EIGHTH EDITION Abel Bernanke Croushore
Symbols Used in This Book A productivity B government debt BASE monetary base C consumption CA current account balance CU currency held by nonbank public DEP bank deposits E worker effort G government purchases I investment INT net interest payments K capital stock KFA capital and financial account balance M money supply MC marginal cost MPK marginal product of capital MPN marginal product of labor MRPN marginal revenue product of labor N employment, labor N full-employment level of employment NFP net factor payments NM nonmonetary assets NX net exports P price level P e expected price level P sr short-run price level R real seignorage revenue RES bank reserves S national saving S pvt private saving S govt government saving T taxes TR transfers V W Y Y a c cu d e e nom e nom i i m k n p K r r w r a-t res s t u u uc w y p p e h Y t velocity nominal wage total income or output full-employment output individual wealth or assets individual consumption; consumption per worker currency deposit ratio depreciation rate real exchange rate nominal exchange rate official value of nominal exchange rate nominal interest rate nominal interest rate on money capital labor ratio growth rate of labor force price of capital goods expected real interest rate world real interest rate expected after-tax real interest rate reserve deposit ratio individual saving; saving rate income tax rate unemployment rate natural unemployment rate user cost of capital real wage individual labor income; output per worker inflation rate expected inflation rate income elasticity of money demand tax rate on firm revenues
200 Part 2 Long-Run Economic Performance $164.8 billion (see the line Foreign official assets ). The official settlements balance also called the balance of payments is the net increase (domestic less foreign) in a country s official reserve assets. A country that increases its net holdings of reserve assets during a year has a balance of payments surplus, and a country that reduces its net holdings of reserve assets has a balance of payments deficit. For the United States in 2011 the official settlements balance was - +148.9 billion (equal to the +15.9 billion increase in U.S. reserve assets minus the $164.8 billion increase in foreign dollar-denominated reserve assets). Thus the United States had a balance of payments deficit of $148.9 billion in 2011. For the issues we discuss in this chapter, the balances on current account and on capital and financial account play a much larger role than the balance of payments. We explain the macroeconomic significance of the balance of payments in Chapter 13 when we discuss the determination of exchange rates. The Relationship Between the Current Account and the Capital and Financial Account The logic of balance of payments accounting implies a close relationship between the current account and the capital and financial account. Except for errors arising from problems of measurement, in each period the current account balance and the capital and financial account balance must sum to zero. That is, if then CA = current account balance and KFA = capital and financial account balance, CA + KFA = 0. (5.1) The reason that Eq. (5.1) holds is that every international transaction involves a swap of goods, services, or assets between countries. The two sides of the swap always have offsetting effects on the sum of the current account and the capital and financial account balances, CA + KFA. Thus the sum of the current account and the capital and financial account balances must equal zero. Table 5.2 helps clarify this point. Suppose that a U.S. consumer buys an imported British sweater, paying $75 for it. This transaction is an import of goods to the United States and thus reduces the U.S. current account balance by $75. However, the British exporter who sold the sweater now holds $75. What will he do with it? There are several possibilities, any of which will offset the effect of the purchase of the sweater on the sum of the current account and the capital and financial account balances. The Briton may use the $75 to buy a U.S. product say, a computer game. This purchase is a $75 export for the United States. This U.S. export, together with the original import of the sweater into the United States, results in no net change in the U.S. current account balance CA. The U.S. capital and financial account balance KFA hasn t changed, as no assets have been traded. Thus the sum of CA and KFA remains the same. A second possibility is that the Briton will use the $75 to buy a U.S. asset say, a bond issued by a U.S. corporation. The purchase of this bond is a financial inflow to the United States. This $75 increase in the U.S. capital and financial account offsets the $75 reduction in the U.S. current account caused by the original import
Chapter 5 Saving and Investment in the Open Economy 201 Table 5.2 Why the Current Account Balance and the Capital and Financial Account Balance Sum to Zero: An Example (Balance of Payments Data Refer to the United States) Case I: United States Imports $75 Sweater from Britain; Britain Imports $75 Computer Game from United States Current Account Exports + +75 Imports - +75 Current account balance, CA 0 Capital and Financial Account No transaction Capital and financial account balance, KFA 0 Sum of current and capital and financial account balances, CA + KFA 0 Case II: United States Imports $75 Sweater from Britain; Britain Buys $75 Bond from United States Current Account Imports - +75 Current account balance, CA - +75 Capital and Financial Account Financial inflow + +75 Capital and financial account balance, KFA + +75 Sum of current and capital and financial account balances, CA + KFA 0 Case III: United States Imports $75 Sweater from Britain; Federal Reserve Sells $75 of British Pounds to British Bank Current Account Imports - +75 Current account balance, CA - +75 Capital and Financial Account Financial inflow (reduction in U.S. official reserve assets) + +75 Capital and financial account balance, KFA + +75 Sum of current and capital and financial account balances, CA + KFA 0 of the sweater. Again, the sum of the current account and the capital and financial account balances, CA + KFA, is unaffected by the combination of transactions. Finally, the Briton may decide to go to his bank and trade his dollars for British pounds. If the bank sells these dollars to another Briton for the purpose of buying U.S. exports or assets, or if it buys U.S. assets itself, one of the previous two cases is repeated. Alternatively, the bank may sell the dollars to the Federal Reserve in exchange for pounds. But in giving up $75 worth of British pounds, the Federal Reserve reduces its holdings of official reserve assets by $75, which counts as a financial inflow. As in the previous case, the capital and financial account balance rises by $75, offsetting the decline in the current account balance caused by the import of the sweater. 3 This example shows why, conceptually, the current account balance and the capital and financial account balance must always sum to zero. In practice, 3 In this case, the balance of payments falls by $75, reflecting the Fed s loss of official reserves. We didn t consider the possibility that the Briton would just hold $75 in U.S. currency. As dollars are an obligation of the United States (in particular, of the Federal Reserve), the Briton s acquisition of dollars would be a credit item in the U.S. capital and financial account, which would offset the effect of the sweater import on the U.S. current account.
202 Part 2 Long-Run Economic Performance problems in measuring international transactions prevent this relationship from holding exactly. The amount that would have to be added to the sum of the current account and the capital and financial account balances for this sum to reach its theoretical value of zero is called the statistical discrepancy. As Table 5.1 shows, in 2011 the statistical discrepancy was $80.5 billion. In addition to the statistical discrepancy in the United States, there is frequently a statistical discrepancy across all the countries in the world. Because every export is somebody else s import, exports for the world as a whole must equal imports and the current account surplus of the world must be zero. But when official current account figures for all nations are added up, the result is sometimes a large current account deficit for the world and other times a large current account surplus. The explanation lies in statistical and measurement problems, especially the misreporting of income from assets held abroad. When you examine the data on the current account across countries, you see that for most of the past decade, the advanced economies of the world on the whole ran a large current account deficit, while emerging and developing economies around the world ran a very large current account surplus. This means the emerging and developing economies have invested some of their saving in developed countries. See the Application: Recent Trends in the U.S. Current Account Deficit, p. 217, for some reasons why this may have occurred. Net Foreign Assets and the Balance of Payments Accounts In Chapter 2 we defined the net foreign assets of a country as the foreign assets held by the country s residents (including, for example, foreign stocks, bonds, or real estate) minus the country s foreign liabilities (domestic physical and financial assets owned by foreigners). Net foreign assets are part of a country s national wealth, along with the country s domestic physical assets, such as land and the capital stock. The total value of a country s net foreign assets can change in two ways: (1) the value of existing foreign assets and foreign liabilities can change, as when stock held by a U.S. citizen in a foreign corporation increases in value or the value of U.S. farmland owned by a foreigner declines; and (2) the country can acquire new foreign assets or incur new foreign liabilities. What determines the quantity of new foreign assets that a country can acquire? In any period the net amount of new foreign assets that a country acquires equals its current account surplus. For example, suppose a country exports $10 billion more in goods and services than it imports and thus runs a $10 billion current account surplus (assuming that net factor payments from abroad, NFP, and net unilateral transfers both are zero). The country must then use this $10 billion to acquire foreign assets or reduce foreign liabilities. In this case we say that the country has undertaken net foreign lending of $10 billion. Similarly, if a country has a $10 billion current account deficit, it must cover this deficit either by selling assets to foreigners or by borrowing from foreigners. Either action reduces the country s net foreign assets by $10 billion. We describe this situation by saying that the country has engaged in net foreign borrowing of $10 billion. One important way in which a country borrows from foreigners occurs when a foreign business firm buys or builds capital goods; this is known as foreign direct investment. For example, when the Honda Motor Company from Japan builds a new auto production facility in Ohio, it engages in foreign direct
Chapter 5 Saving and Investment in the Open Economy 203 Summary 7 Equivalent Measures of a Country s International Trade and Lending Each Item Describes the Same Situation A current account surplus of $10 billion A capital and financial account deficit of $10 billion Net acquisition of foreign assets of $10 billion Net foreign lending of $10 billion Net exports of $10 billion (if net factor payments, NFP, and net unilateral transfers equal zero) investment. Because the facility is built in the United States but is financed by Japanese funds, foreign-owned assets in the United States increase, so the capital and financial account balance increases. Foreign direct investment is different from portfolio investment, in which a foreigner acquires securities sold by a U.S. firm or investor. An example of portfolio investment occurs when a French investor buys shares of stock in General Motors Corporation. This transaction also increases the capital and financial account balance, as it represents an increase in foreign-owned assets in the United States. Equation (5.1) emphasizes the link between the current account and the acquisition of foreign assets. Because CA + KFA = 0, if a country has a current account surplus, it must have an equal capital and financial account deficit. In turn, a capital and financial account deficit implies that the country is increasing its net holdings of foreign assets. Similarly, a current account deficit implies a capital and financial account surplus and a decline in the country s net holdings of foreign assets. Summary table 7 presents some equivalent ways of describing a country s current account position and its acquisition of foreign assets. Application The United States as International Debtor From about World War I until the 1980s, the United States was a net creditor internationally; that is, it had more foreign assets than liabilities. Since the early 1980s, however, the United States has consistently run large annual current account deficits. These current account deficits have had to be financed by net foreign borrowing (which we define broadly to include the sale of U.S.-owned assets to foreigners as well as the incurring of new foreign debts). The accumulation of foreign debts and the sale of U.S. assets to foreigners have, over time, changed the United States from a net creditor internationally to a net debtor. Figure 5.1 shows the U.S. ownership of foreign assets and foreign ownership of U.S. assets, both measured as a percent of U.S. GDP, since 1982. As you can see, foreign ownership of U.S. assets overtook the U.S. ownership of foreign assets in the mid 1980s and the gap between the two has grown substantially since then. According to estimates by the Bureau of Economic (continued)
204 Part 2 Long-Run Economic Performance Figure 5.1 MyEconLab Real-time data International ownership of assets relative to U.S. GDP, 1982 2011 The chart shows annual values for ownership of foreign assets by U.S. residents and ownership of U.S. assets by foreigners, each as a percentage of U.S. GDP for the period 1982 to 2011. Sources: International ownership of assets: Bureau of Economic Analysis, International Economic Accounts, International Investment Position, Table 2, available at www.bea.gov/ international/xls/intinv11_t2.xls. GDP: Bureau of Economic Analysis, National Income and Product Accounts, available at research.stlouisfed.org/fred2/ series/gdpa. Percent of GDP 180 160 140 120 100 80 60 40 20 FOREIGN OWNERNSHIP OF U.S. ASSETS/U.S. GDP U.S. OWNERSHIP OF FOREIGN ASSETS/U.S. GDP 0 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Year Analysis, at the end of 2011 the United States had net foreign assets of - +4030 billion, measured at current market prices. Equivalently, we could say that the United States had net foreign debt of $4030 billion. 4 This international obligation of more than $4 trillion is larger than that of any other country, making the United States the world s largest international debtor. This figure represented an increase of indebtedness of $1557 billion from yearend 2010. The U.S. current account deficit in 2011 was $473 billion. But the net debt of the United States rose much more than that in part because of decreases in the value of U.S.-owned assets abroad relative to the value of foreign-owned assets in the United States. Although the international debt of the United States is large and growing, the numbers need to be put in perspective. First, the economic burden created by any debt depends not on the absolute size of the debt but on its size relative to the debtor s economic resources. Even at $4030 billion, the U.S. international debt is only about 27% of one year s GDP (U.S. GDP in 2011 was $15,076 billion). By contrast, some countries, especially certain developing countries, have ratios of net foreign debt to annual GDP that exceed 100%. Second, the large negative net foreign asset position of the United States doesn t imply that it is being bought up or controlled by foreigners. If we focus on foreign direct investment, in which 4 These and other data in this application are from Elena L. Nguyen, The International Investment Position of the United States at Yearend 2011, Survey of Current Business, July 2012, pp. 9 18.