National Income, BOP Accounting and Central Banking Monetary Theory and Policy UFM Summer, 2006

1. National Income Accounting  Y = C + I + G + CA S = Y – C – G  Sp = I + CA – Sg = I + CA – (T – G) = I + CA + (G – T)  Private saving (Sp): The part of disposable income that is saved rather than consumed T is the government's “income” (its net tax revenue)  Sg is government savings (T-G)

Four different ways to describe the current account:  a. change in net foreign assets  b. national saving net of investment  c. income minus absorption  d. trade balance plus net factor payments from abroad absorption approach, elasticity approach  Issues: *Causes of current account deficit *Adding up the world CA is not equal to 0?

2. The Balance of Payments Accounts  CA +FA = 0  CA+FA+OSA=0  CA+FA=BOP  CA+ FA + KA + S & O+ OSA =0  A country ’ s balance of payments accounts keep track of both its payments to and its receipts from foreigners.  Every international transaction automatically gives rise to two offsetting entries in the balance of payments resulting in a fundamental identity : once as a credit (+) and once as a debit (-).

The Balance of Payments Accounts  THE BALANCE OF PAYMENTS is a record of all transactions between domestic residents and the rest of the world. Examples: goods and services, license fees, interest income, dividends, real assets (factories, land), financial assets (stocks, bonds, bank deposits, loans), unilateral transfers (foreign aid, private gifts).  Rule: Sell something to rest of world, receive payment  enters as credit (+). Buy something from rest of the world, make payment  enters as debit (-).  Think: all international transactions require foreign currency. All credit transactions give rise to supply of foreign exchange. All debit transactions give rise to demand for foreign exchange.

The Balance of Payments Accounts  Three types of international transactions are recorded in the balance of payments: –Exports or imports of goods or services recorded in the current account –Purchases or sales of financial assets recorded in the financial account –Transfers of wealth between countries recorded in the capital account.

The Balance of Payments Accounts  Examples of Paired Transactions –A U.S. citizen buys a $1000 typewriter from an Italian company, and the Italian company deposits the $1000 in its account at Citibank in New York.  That is, the U.S. trades assets for goods.  This transaction creates the following two offsetting entries in the U.S. balance of payments: –It enters the U.S. CA with a negative sign (-$1000). –It shows up as a $1000 credit in the U.S. financial account.

The Balance of Payments Accounts –A U.S. citizen pays $200 for dinner at a French restaurant in France by charging his Visa credit card.  That is, the U.S. trades assets for services.  This transaction creates the following two offsetting entries in the U.S. balance of payments: –It enters the U.S. CA with a negative sign (-$200). –It shows up as a $200 credit in the U.S. financial account.

The Balance of Payments Accounts –A U.S. citizen buys a $95 newly issued share of stock in the United Kingdom oil giant British Petroleum (BP) by using a check drawn on his stockbroker money market account. BP deposits the $95 in its own U.S. bank account at Second Bank of Chicago.  That is, the U.S. trades assets for assets.  This transaction creates the following two offsetting entries in the U.S. balance of payments: –It enters the U.S. financial account with a negative sign (-$95). –It shows up as a $95 credit in the U.S. financial account.

CA: 4 components  Commodity Service Factor Income Unilateral Transfer Issues: *Net international investment position (ex. USA) *Negative 5% is the threshold for currency crisis *Persistent, sustainable, excessive, and solvent *A mirror of FA *International risk portfolio diversification *Stock and flow view of CA

FA: 3 components  Foreign Direct Investment Portfolio Investment (stock and bond) Other Investment (bank loans)  Issues: *Liberalization of FA *Pace, sequence, volume of capital mobility *Policy response to capital inflow *Economic growth and types of capital flow *Components of FA and its effect on CA (S & I) *M&A (Merger and Acquisition) *Pension fund, mutual fund, and hedge fund *Capital account crisis

OSA: (-BOP)  Change of foreign reserves  Issues: *BOP crisis *Over-holding of foreign reserves (3-6 months of imports): cost and benefit (ex. Asian countries after crisis) *Flow and stock (total reserves minus gold)

3. Central Bank Balance Sheet  B: monetary base, includes currency and commercial bank reserves or deposits at the central bank. D: domestic credit, includes US treasury debt and discount lending : foreign exchange reserves  Issues: *Central Bank’s Balance Sheet *Holding reserves *Foreign exchange market intervention *Sterilization *Monetization of government debt