those available from the exchange of assets:
GNE + CA + FA + KA = GNDI
How the Balance of Payments Accounts Work: A Microeconomic View The balance
of payments must balance. The sum of the current account, the capital account, and the
financial account must equal zero. The BOP identity can be rewritten as
The previous expression shows that each transaction in the BOP must involve a BOP
credit and a BOP debit so that the identity is satisfied.
BOP Credits:
Current account (CA) Exports of goods and services (+EX)
Financial account (FA) Exports of home and foreign assets (+EXHA, +EXFA)
BOP Debits:
Current account (CA) Imports of goods and services (−IM)
Side Bar: The Double–Entry Principle in the Balance of Payments
The following examples differ from those in the textbook. This is to provide additional
examples for lectures. They mirror those in the textbook, but are based on the perspective
of the United States as the home country.
1. Suppose an American, David, is visiting Milan on business selling messenger
bags to merchants. He spends a total of $800 (€500) for his hotel. David pays for
his hotel using his MasterCard (issued by a U.S. bank). The Milanese hotel now
2. In Milan, David meets with an Italian business associate, Francesco. Francesco
plans to purchase a dozen of David’s messenger bags (worth $120 each) for a
bicycle messenger service he owns. He pays David the $1,440 using a checking
3. Later that evening, David meets a friend of his from college, Margrit, who is on
vacation in Milan from Switzerland. He learns that Margrit has gone into business
as a watchmaker. Wanting to try David’s messenger bag for her own use, Margrit
4. Before going to sleep that evening, David decides to watch a soccer match
between the home Italian team versus an English team. He sees that the English
team is sponsored by Emirates, a luxury airline based in the United Arab
Emirates. After reviewing Emirates’ annual report, he decides to purchase $5,000
5. The next morning, David learns that a hurricane has hit the Gulf of Mexico,
destroying buildings in Louisiana and Mississippi. A German firm donates
emergency cell phones and Internet satellite communications worth $40,000 for
households and businesses affected by the disaster. In the U.S. current account,
6. In response to the hurricane, South Korea pledges to donate $3.8 million in cash
(U.S. dollars) toward the relief effort. This decreases U.S. assets owned abroad (in
South Korea), which are returned to the United States as a gift (on the capital
account).
FA: Decrease in U.S. external liabilities −IMHA: −$3.8 million
Understanding the Data for the Balance of Payments Accounts
This section shows the U.S. BOP for 2009. The accounts are listed according to the order
given previously: CA, KA, FA, and the statistical discrepancy.
A country with a current account surplus is a (net) lender; one with a current account
deficit is a (net) borrower.
The country imports more external assets than it exports (lends financial resources to the
rest of the world [ROW]). The country exports more goods than it imports (lends goods
and services to ROW).
The country imports more goods and services than it exports (borrows from ROW). The
country exports more external assets than it imports (borrows from ROW).
The United States is a net borrower, with
■ A financial outflow (or capital outflow) refers to financial purchases by home
entities of foreign assets.
■ A financial inflow (or capital inflow) refers to financial purchases by foreign
entities of home assets.
In the United States (2009), financial outflow = $140 billion and financial inflow =
$306 billion.
Central bank interventions are recorded on the financial account because they involve
the exchange of home and foreign assets. To isolate these transactions from other FA
account transactions, we can divide the FA account into reserve and nonreserve
components:
In the United States (2009), there were significant central bank interventions, with an
official settlements balance of +$398 billion. However, the Fed’s intervention was
The Statistical Discrepancy The statistical discrepancy (SD) refers to the failure of the
BOP identity based on the data collected. In reality, the current account may not be
exactly equal to the sum of the capital and financial accounts, so CA ≠ KA + FA. The
Some Recent Trends in the U.S. Balance of Payments Since 1990, the U.S. current
What the Balance of Payments Account Tells Us
From the preceding definitions, we see that imbalances (surplus or deficit) in one account
must be offset by imbalances in another.
The capital account balance is very small relative to the current account and financial
account balances. (In fact, for 2009, the capital account balance was $0.) It seems safe to
4 External Wealth
When a country lends or borrows each year, it adds to or subtracts from its external
wealth, the sum of the foreign assets owned by the home country less the home assets
The Level of External Wealth
∆W Net export of assets Valuation effects
= =
∆W CA KA Valuation effects
= = =
Like net worth, external wealth is equal to assets less liabilities, except here we
consider the exchange of foreign and home assets between the home country and the rest
of the world. The link between total wealth in a country and its external wealth is detailed
in the appendix.
Changes in External Wealth
External wealth changes for two reasons:
1. Financial flows. Changes on the financial account (FA). Examples include:
■ Export of home assets to ROW leads to an increase in external liabilities (FA
2. Valuation effects. Changes associated with the value of financial assets owned in
home country and ROW. Capital gains or losses: Increase or decrease in value of
asset. Examples include:
■ Decrease in the price of German stocks: Americans who own German stock
experience capital losses, decreasing external wealth.
W A L
From this expression, we see that a country can increase external wealth in three ways:
■ Capital gains on external assets (valuation effects)
Understanding the Data on External Wealth
National external wealth is measured using an account known as the net international
investment position. Table 16-4 reports a simplified version of this account for the United
States from 2008 to 2009.
We observe from the United States (2009):
Why the large valuation effects? Two reasons:
■ Worldwide increase in equity values (stock prices).
■ The U.S. dollar depreciated vis-à-vis most major currencies. About 95% of U.S.
Some Recent Trends
The persistent financial account surpluses and current account deficits tend to reduce U.S.
external wealth. However, the United States has benefited from large valuation effects,
which generate capital gains for the United States but capital losses for the rest of the
What External Wealth Tells Us
External wealth reveals a country’s status as a net creditor or debtor with the rest of the
world. It includes data on the exchange of financial assets and liabilities (also recorded on
the BOP in the financial account).
5 Conclusions
Before analyzing how the flow of goods, services, and financial assets affects the
S I D E B A R
Beware of Greeks Bearing Statistics
It’s depressing, but not particularly surprising, to find out that some governments have
deliberately manipulated their official economic data. The most recent example is
Greece. In 2001, Greece adopted the euro. In order to join the Eurozone, the Greek
government’s budget deficit had to be less than 3% of the nation’s GDP. In 2004, Greece
Appendix: External Wealth and Total WealthTotal wealth is the sum of home capital
stock (nonfinancial assets in the home country [K]) plus the amounts owed to the home
country from ROW (A) minus the amounts owed to ROW by the home country (L). Total
wealth can be defined as the sum of domestic wealth (K) plus external wealth (A − L):
Total wealth = K + (A − L)
Therefore,
Change in total wealth = I + (–FA) + Capital gains on K + Capital gains on (A − L)
Substituting in the BOP identity: (CA + KA = FA)
TEACHING TIPS
Teaching Tip 1: Gross National Expenditure (GNE) measures “total expenditure on final
goods and services by home entities in any given period of measurement” (textbook, full
Teaching Tip 2: Using the data table from Teaching Tip 1 and the Excel worksheet that
IN–CLASS PROBLEMS
1. The textbook discusses many different definitions of national and domestic
production, income, and expenditures. Consider the following measures: GDP, GNI,
and GNDI. Which do you believe is the most accurate measure of economic
performance and why?
Answer: The textbook argues that GNDI is the most accurate measure of economic
activity because it measures disposable income earned by home country factors of
2. Refer to the table in Question 1 of the end-of-chapter questions. The table shows that
economic performance depends on which empirical measure we choose. Consider the
United Kingdom and Australia. Based on each country’s experience with GNI and
GDP, which one is more like Ireland? What does this imply about production by each
country’s factors of production?
Answer: Based on the data, Australia is more like Ireland. Recall from the chapter
3. Assume the following accounting identity for gross national disposable income:
a. Starting with this definition, show that the current account is equal to domestic
savings less domestic investment.
Answer: From the GNI identity, we know that
Rearranging gives us
b. From the expression in (a), show that the current account plus investment is equal
to private saving plus government saving.
Answer: Private savings, SP, and government savings, SG, are defined as
c. From the expression in (b), show that an increase in government spending can
lead to a reduction in the current account.
Answer: An increase in government spending, G, leads to a decrease in
government saving:
4. Use the following information on a hypothetical economy, Rijkdom, for the year
2006:
Balance of Payments Accounts
National Income and Product
Accounts
Current account surplus of $1 billion
GNE of $8 billion ($8,000 million)
Nonreserve financial account deficit of
$850 million
Consumption of $5 billion ($5,000
million)
Capital account surplus of $75 million
Total government purchases of $1.1
billion ($1,100 million)
Earnings of $150 million for foreign
factors located in Rijkdom
A $250 million government budget
deficit
Trade surplus of $700 million
Net of −$50 million in unilateral transfers
a. Calculate Rijkdom’s financial account balance. What has happened to Rijkdom’s
foreign asset position? Explain in detail in terms of Rijkdomian assets and foreign
assets (owned by Rijkdomians and foreigners).
Answer: From the BOP identity: