Slide 12-1Copyright © 2003 Pearson Education, Inc. The National Income Accounts  Gross national product (GNP) The value of all final goods and services produced by a country’s factors of production, whether in-country or abroad and sold on the market in a given time period GNP is calculated by adding up the market value of all expenditures on final output Y = C + I + G + EX – IM Y = C + I + G + CA

Slide 12-2Copyright © 2003 Pearson Education, Inc. National Income Accounting for an Open Economy  Consumption The portion of GNP purchased by the private sector to fulfill current wants  Investment The part of output used by private firms to produce future output  Government Purchases Any goods and services purchased by federal, state, or local governments

Slide 12-3Copyright © 2003 Pearson Education, Inc. The National Income Accounts Figure 12-1: U.S. GNP and Its Components, 2000

Slide 12-4Copyright © 2003 Pearson Education, Inc. National Product and National Income National Income: income earned by a nation’s factors of production over some period of time. –NI equals a country’s GNP net of receipts not available for distribution (depreciation, indirect business taxes). –Unilateral transfers from foreigners add to NI but not to GNP. Gross Domestic Product (GDP) GDP measures the volume of production within a country’s borders. GDP = GNP – [Net receipts of factor income from abroad]. –Income earned from production abroad obviously doesn’t count in gross domestic product. The National Income Accounts

Slide 12-5Copyright © 2003 Pearson Education, Inc. GNP is the sum of domestic and foreign expenditure on the goods and services produced by domestic factors of production, whether in-country or abroad: Y = C + I + G + EX – IM where: –Y is GNP –C is consumption –I is investment –G is government purchases –EX is exports –IM is imports In a closed economy, EX = IM = 0. National Income Accounting for an Open Economy

Slide 12-6Copyright © 2003 Pearson Education, Inc.  The Current Account and Foreign Indebtedness Current account (CA) balance CA = EX – IM = Y – (C + I + G) CA measures the size and direction of international borrowing. –If we import more than we export (CA<0), we must pay for the difference by borrowing from foreigners. –A country’s current account balance equals the change in its net foreign wealth. National Income Accounting for an Open Economy

Slide 12-7Copyright © 2003 Pearson Education, Inc. CA = National income – (Domestic residents’ spending) Y – (C+ I + G) = CA CA balance is what we produce (Y) minus domestic demand or “absorption”. –We can “live beyond our means” if we run a current account deficit, import more than we export, and borrow the difference from foreigners. CA balance is the excess supply of domestic financing. –If we produce and earn more than we “absorb” (CA>0), we necessarily lend our “excess” saving to foreigners »Think of Japan –If we want foreigners to buy more currently produced things from us than we buy from them, we must lend them the difference National Income Accounting for an Open Economy

Slide 12-8Copyright © 2003 Pearson Education, Inc. The U.S. Current Account and Net Foreign Wealth Position, … and our current account deficit has widened BIG TIME since 2000

Slide 12-9Copyright © 2003 Pearson Education, Inc.  Saving and the Current Account National saving (S): the portion of output, Y, that is not devoted to consumption, C, or government purchases, G. S = Y – C – G = Investment in a closed economy. A closed economy can save only by building up its capital stock An open economy can save either by building up its capital stock or by acquiring foreign wealth S = Y – C – G = I + CA If saving doesn’t finance domestic investment, it’s got to finance foreign investment. CA surplus = Net Foreign Investment. National Income Accounting for an Open Economy

Slide 12-10Copyright © 2003 Pearson Education, Inc. Private saving (S p ): The part of disposable income that is saved rather than consumed Government Saving (S g ): The excess of tax revenue (T) over government spending (G) Sources of Income = Uses of Income C + I + G + CA = T + S p + C I = S p + (T – G) – CA = Nat’l Saving + Capital Inflows Nat’l Borrowing = – CA = (I – S p ) + (G – T) Twin Deficits S p = I + CA – S g = I + CA – (T – G) = I + (G – T) + CA Private saving must either finance domestic investment, a government deficit, or it must be invested abroad. Private and Government Saving Domestic and Net Foreign Investment

Slide 12-11Copyright © 2003 Pearson Education, Inc.  Three types of international transactions are recorded in the balance of payments: Exports or imports of goods or services appear in the current account Purchases or sales of financial assets appear in the financial account –The financial account is a new accounting category –These transactions used to be included in the capital account Transfers of wealth between countries are recorded in the capital account –Magnitudes of transactions in this account are relatively small –Most of what used to appear in the capital account now appears in the financial account. The Balance of Payments Accounts

Slide 12-12Copyright © 2003 Pearson Education, Inc. The Fundamental Balance of Payments Identity Any international transaction automatically gives rise to two offsetting entries in the balance of payments resulting in a fundamental identity: Current account + financial account + capital account = 0

Slide 12-13Copyright © 2003 Pearson Education, Inc. A U.S. citizen pays $200 for dinner at a French restaurant in France by charging his Visa credit card (the U.S. trades assets for services). This transaction enters the U.S. CA with a negative sign (a $200 import). It is a $200 credit in the U.S. financial account (the French have lent us $200). A U.S. citizen buys a $1000 Italian typewriter; the Italian company deposits the $1000 in its account at Citibank in New York (the U.S. trades assets for goods). This transaction enters the U.S. CA with a negative sign (a $1000 import). It shows up as a $1000 credit in the U.S. financial account ($1000 inflow to Citi). A U.S. citizen buys a $95 newly issued share of stock in the UK oil giant British Petroleum (BP), paying with a check drawn on his money market account. BP deposits the $95 in its own U.S. bank account at Citibank (the U.S. trades assets for assets). –The share enters the U.S. financial account with a negative sign (-$95, a financial outflow). –The check shows up as a $95 credit in the U.S. financial account (+$95, a financial inflow to Citibank). The Balance of Payments Accounts:Examples of Paired Transactions

Slide 12-14Copyright © 2003 Pearson Education, Inc. The Balance of Payments Accounts Table 12-2: U.S. Balance of Payments Accounts for 2000 (billions of dollars)

Slide 12-15Copyright © 2003 Pearson Education, Inc. The Balance of Payments Accounts Table 12-2: Continued

Slide 12-16Copyright © 2003 Pearson Education, Inc.  Official Reserve Transactions Central bank –The institution responsible for managing the supply of money Official international reserves –Foreign assets held by central banks as a cushion against national economic misfortune Official foreign exchange intervention –Central banks often buy or sell international reserves in private asset markets to affect macroeconomic conditions in their economies. The Balance of Payments Accounts

Slide 12-17Copyright © 2003 Pearson Education, Inc. Official settlements balance (Balance of Payments): the sum of the current account balance, the capital account balance, the nonreserve portion of the financial account balance, and the statistical discrepancy. –The U.S. Balance of Payments in 2000 was -$35.6 billion, that is, the balance of official reserve transactions with its sign reversed. – Foreign central banks increased their dollar holdings by $35.9 billion while the Fed increased its holdings of foreign currencies by $0.3 billion, a balance of $35.6 billion flowing out of the US. –A negative balance of payments may signal that a country is running down its international reserve assets or incurring debts to foreign monetary authorities. The Balance of Payments Accounts