Economics Chapter 16 Homework Before getting into the details, let’s look at an overview of the

Unlock access to all the studying documents.

View Full Document

16 National and International Accounts: Income, Wealth, and the

Balance of Payments

Notes to Instructor

Chapter Summary

This chapter begins by discussing an integrated view of national income and product

(NIP) accounts with balance of payments (BOP) accounts. The chapter then presents NIP

accounts in detail. For advanced students, most of this will be a review. The next section

covers BOP accounts, highlighting the double-entry accounting that may be familiar to

Comments

This chapter includes a detailed exposition of NIP and BOP accounts. This exposition

lays the foundation for analysis in Chapter 18; however, much of the detail will be

simplified. The most detailed analyses appear in the applications and sidebars.

First, data are revised frequently. International account revisions are often quite large.

Second, of course, there are newer data available than what’s in the textbook. This

1. Measuring Macroeconomic Activity: An Overview

a. The Flow of Payments in a Closed Economy: Introducing the National

2. National Accounts: Income, Product, and Expenditure

a. Three Approaches to Measuring Economic Activity

b. From GNE to GDP: Accounting for Trade in Goods and Services

c. From GDP to GNI: Accounting for Trade in Factor Services

d. Application: Celtic Tiger or Tortoise?

e. From GNI to GNDI: Accounting for Transfers of Income

3. Balance of Payments

a. Accounting for Asset Transactions: The Financial Account

b. Accounting for Asset Transactions: The Capital Account

c. Accounting for Home and Foreign Assets

4. External Wealth

a. The Level of External Wealth

5. Conclusions

a. Side Bar: Beware of Greeks Bearing Statistics

Lecture Notes

In the next three chapters, we shift our focus to economic transactions between countries

that involve the trade of goods and services and the exchange of assets.

The measurement of aggregate variables is a key component of macroeconomic

analysis. In the closed economy, we focus on the behavior of components of spending:

consumption, investment, and government purchases. In an open economy, the flow of

goods, services, and assets has implications for key macroeconomic variables such as

GDP. For example, is a trade deficit a bad thing? Is it a sign of an imbalance in the

1 Measuring Macroeconomic Activity: An Overview

This chapter relies on accounting principles used to track flows of income, spending, and

production in both closed and open economies. These flows are modeled with the circular

The Flow of Payments in a Closed Economy: Introducing the National Income and

Product Accounts

Figure 16-1 in the text shows the circular flow for a closed economy. Gross national

expenditure (GNE) represents the economy’s total spending on final goods and services.

It can be divided into three components:

■ Personal consumption expenditures (consumption) are the total spending by

households on final goods and services.

Note that GNE is equal to total spending on final goods and services. Firms also sell

intermediate goods and services, which are used in the production of final goods and

services. Firms use the revenues collected from selling both final and intermediate goods

and services in two ways:

■ payments for intermediate goods and services

■ income payments for factors of production, such as wages and salaries to labor,

dividends and interest to capital, and rent to landowners

In the closed economy, spending must be equal to production, or GNE = GDP. The

value added is paid as income to factors of production, such as households, government,

The Flow of Payments in an Open Economy: Incorporating the Balance of

Payments Accounts

A nation’s BOP account records international transactions in the open economy. In this

case, the three key variables defined previously—GNE, GDP, and GNI—need not be

equal. Figure 16-2 shows the circular flow for an open economy with the BOP. The key

equations covered later in the chapter are shown in the following.

There are five key points in Figure 16-2 that highlight the nature of international

transactions.

1. GNE + TB = GDP TB = EX − IM

2. GDP + NFIA = GNI NFIA = EXFS − IMFS

Factors of production may be imported from abroad; factor services may be

3. GNI + NUT = GNDI NUT = UTIN − UTOUT

The country’s available (retained) income may differ from its income earned

because of unilateral transfers to (UTOUT) and from abroad (UTIN). The net

4. FA = EXA − IMA

We observe that the economy can increase or decrease the resources available for

5. KA = KAIN − KAOUT

6. GNDI + FA + KA = GNE

From studying the circular flows, we learn two important lessons. First, all transactions

within the domestic economy are recorded in the NIP accounts, with the net international

transactions affecting a nation’s expenditure, production, and income. The flows into and

out of the country are recorded on the BOP.

2 National Accounts: Product, Expenditure, and Income

This section reviews NIP accounts, highlighting the distinctions among expenditure,

production, and income that are important in the open economy.

Three Approaches to Measuring Economic Activity

There are three approaches to measuring economic activity:

■ Expenditure approach: GNE

Demand for final goods and services

GNE = total expenditure on all final goods and services

■ Product approach: GDP

From GNE to GDP: Accounting for Trade in Goods and Services

Recall that the GNE is the sum of personal consumption expenditures (C), gross private

domestic investment (I), and government consumption expenditures and gross investment

(G):

GNE measures domestic spending. But that includes spending on products produced in

other countries that are not part of domestic production. Because GDP measures

exports (again, including both final and intermediate products).

This expression is the GDP identity: GDP is equal to the GNE plus the TB.

The trade balance is also known as net exports. It can be either positive or negative:

From GDP to GNI: Accounting for Trade in Factor Services

Trade in factor services occurs when one country is paid income by another in

compensation for labor, capital, and land. A country exports factor services and receives

factor income in return. Factor income includes payments for labor services (wages and

salaries), payments on income from assets (dividends or interest), and payments for use

of land (rent). Foreign direct investment (FDI) is an example of trade in capital services.

When a firm builds or purchases a physical asset in another country, it is engaging in

FDI. That investment will produce future income for the firm in its home country. FDI is

APPLICATION

Celtic Tiger or Tortoise?

Trade in factor services can explain differences between a country’s GNI and its GDP:

GNI = GDP + NFIA

In the early 1970s, Ireland was one of the poorer countries in Europe. Between 1980 and

2007, its real GDP per person grew at 4.1% per year, an exceptional growth rate

This highlights why GDP may be a misleading measure of economic performance.

The Irish outflow of net factor payments demonstrates how countries that rely heavily on

factor services from abroad can achieve a growth in GDP that is not coupled with a

From GNI to GNDI: Accounting for Transfers of Income

International nonmarket transactions affect the income available for spending in the

economy (Y). Foreign aid, charitable gifts, and income remittances by individuals are

recorded as transfers on the BOP.

Y = GNDI = GNI + NUT From here on, we will use GNDI as our measure of national

income (Y). This corresponds to the resources available to households, firms, and the

What the National Economic Aggregates Tell Us

We arrive at three key expressions for the open economy from the derivations given

previously:

GDP = GNE + TB

Combining these, we see that

Y = GNDI = GNE + TB + NFIA + NUT

This expression shows how international transactions affect the NIP accounts. We can

H E A D L I N E S

Are Rich Countries “Stingy” with Foreign Aid?

Background:

Following the December 26, 2004, tsunami, United Nations Undersecretary for

Humanitarian Affairs and Emergency Relief Jan Egeland stated, “It is beyond me why we

are so stingy.” This was in response to the relatively low assistance given, especially

from the United States, which fell below the United Nation’s goal of 0.7% of GNI.

Key Findings:

■ In 2003, the United States gave double the aid of the second largest donor, Japan.

■ In per person terms, the United States is at the bottom of the list, officially

Understanding the Data for the National Economic Aggregates

This section explains the NIP accounts for the United States in 2009. (All figures are in

billions of dollars.) The important data are:

■ TB = –$392; GNE > GDP; expenditure > production

Some Recent Trends Figure 16-5 shows the shares of GNE: consumption (68.9%),

government consumption (20.0%), and investment (11.1%). Investment tends to fluctuate

more than the other two components. Figure 16-6 shows the current account (CA) over

What the Current Account Tells Us

Note that national income can be expressed as

This is the national income identity: national income is equal to expenditure plus the

current account. From this expression, we see that

■ GNDI > GNE if and only if CA > 0—current account surplus

This expression is the current account identity. The current account is equal to the

difference between national saving and investment.

■ S > I if and only if CA > 0—current account surplus

APPLICATION

Global Imbalances

We can use the previous expressions to understand the sources of global imbalances—

large current account deficits and surpluses.

From Figure 16-7, we observe the following:

■ Saving and investment have declined steadily in the United States, Japan, and the

euro area. There are two exceptions to this generalization. First, until 2006, U.S.

investment remained around 20% of GDP. The recession that began in 2008

caused a precipitous decline in investment in all three regions. Second, both

saving and investment in other industrial countries have increased fairly steadily

since 1990.

■ U.S. investment demand increased dramatically until 2006, the result of a long

economic expansion.

■ Savings has declined partially because of the increasing fraction of the population

that is older, with their tendency to spend more than their income.

To understand the trends in national saving, we can disaggregate saving between

private saving and government saving. Private saving is equal to disposable income less

consumption:

Government saving is also known as the government budget. It is equal to taxes less

government consumption:

Sg = T − G

CA = SP + Sg − I

It is not clear that budget deficits cause current account deficits. Why not?

■ Private savings may change when the government changes taxes (e.g., tax rates).

Suppose tax rates decrease, causing a decrease in government saving. According

■ The current account may move independently of saving, namely because of

changes in investment. Figures 16-7 and 16-8 illustrate that the current account

does not necessarily follow movements in saving.

All else equal, a budget deficit will be associated with a current account deficit. From

Figure 16-9, we observe:

■ Emerging markets and oil producers began running current account surpluses in

the 1990s.

Note that the current account for the world must be equal to zero. If one country has a

current account deficit, this implies another must have a surplus. In other words, total

exports by all countries in the world must equal total imports.

3 Balance of Payments

The balance of payments accounts keep records of international transactions involving

Accounting for Asset Transactions: The Financial Account

The financial account (FA) records transactions involving financial assets between

residents and nonresidents.

EXA: Export of assets refers to the total value of financial assets received by the rest of

the world from the home country.

FA = EXA − IMA

■ FA < 0: country imported more assets than it exported; country accumulates

Accounting for Asset Transactions: The Capital Account The capital account (KA) is

relatively small, accounting for:

■ the acquisition or disposal of nonfinancial, nonproduced assets (patents,

KA = KAIN − KAOUT

■ KA < 0: country gave more transfers than it received.

Accounting for Home and Foreign Assets

We study financial asset transactions now in more detail to understand the role of the

asset issuer and the asset owner.

FA = EXA − IMA

Note that the previous expressions reveal flows of assets into and out of the home

country:

(EXHA − IMHA) = Net export of home assets = Net additions to external liabilities (home

How the Balance of Payments Accounts Work: A Macroeconomic View

We can derive the relationship among these accounts by using the identities developed in

the preceding section.

Y = GNDI = GNE + TB + NFIA + NUT = GNE + CA

To account for all resources available, we first calculate the resources available from

the exchange of assets: