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MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT

The Current Account, the Balance of Payments, and National Wealth

2nd edition

19-2

Current Account (NA)

National Accounts Approach to the Current Account GNI (GNP) = income generated by domestically

owned factors of production anywhere in the world GDP = C + I + G + NX GNI = GDP + NFP (net factor payments from

abroad) NFP = payments to domestically owned factors

(labor and capital) located abroad minus payments to foreign factors located domestically Payments: (1) net dividends, interest, rent to residents owing

assets abroad and (2) net wages to residents working abroad

19-3

Current Account (NA)

GNI = GDP + NFP total income earned

GNDI = GDP + NFP + NFT GNDI = gross national disposable income NFT = net unilateral transfers abroad

remittances, foreign aid total income available

19-4

Current Account (NA)

Private sector net income = private sector income earned at home (Y or GDP) and abroad (NFP + NFT) payments from the government sector (transfers, TR, and interest on government debt, INT) – taxes paid to government (T)

= Y + NFP+NFT + TR + INT – T Public sector net income = taxes – transfers –

interest payments

= T – TR – INT

19-5

Current Account (NA)

As a check: private income + public income = GNDI

(Y + NFP + NFT + TR + INT – T ) + ( T – TR – INT )

= GDP + NFP+NFT

= GNI + NFT

= GNDI

19-6

Current Account (NA)

Private and Public Saving private saving = private income –

consumption

public saving = public income – public purchases

Spvt (Y NFP + NFT – T TR INT) – C

Sgovt (T – TR – INT) – G

19-7

Current Account (NA)

National Saving = private saving + public saving

S = [(Y NFP + NFT – T TR INT) – C]

+ [ (T – TR – INT) – G]

S = (Y + NFP +NFT) – C – G

S = GNDI – C – G

19-8

Current Account (NA)

S = Y + NFP + NFT – C – G S = (C + I + G + NX) + NFP + NFT – C – G S = I + (NX + NFP + NFT), set CA = NX+NFP+NFT S = I + CA CA = S – I savings-investment approach -if CA<0, then insufficient savings CA = NX + NFP +NFT = NX + (GNDI – GDP) = NX + (GNDI – C –I – G – NX) CA = GNDI – (C + I +G) absorption approach -if CA<0, then living beyond means

19-9

Current Account (CA)

Why Current Account Deficits? CA = S – I CA = Spvt + Sgovt – I investment boom: generally good fall in private saving: good or bad

Attending graduate school: good Luxurious living: bad

fall in government saving: good or bad Public investment : can be good Running chronic deficits: bad

19-10

Current Account (BOP)

Balance of Payments (BOP) Accounting Why BOP Accounting?

BOP analysis helps us understand current account imbalances

BOP analysis helps us understand economic crisis driven by volatile international financial flows

The accounting record of a country’s international transactions

19-11

Current Account (BOP)

Balance of payments accounting Any transaction that involves a flow of funds into

the United States is a credit (+) item (enters with a plus sign); for example, exports

Any transaction involving a flow of funds out of the United States is a debit (–) item (enters with a minus sign); for example, imports

19-12

Current Account (BOP)

(1) Goods & Services Balance -exports -imports

(2) Net investment income (NFP)

(3) Unilateral transfers

(1) Capital Account - unilateral transfers of assets

(2) Financial Account - Foreign Direct Investment (FDI) - Portfolio (i) debt: short-term or long-term (ii) equity

(2) Increase in Official Reserve (Domestic) Assets by Foreign Central Banks

Current Account

Financial and Capital Account

Official Settlements Balance

(1) Increase in Official Reserve (Foreign) Assets by Domestic Central Bank

19-13

Current Account (BOP)

(1) Net exports of goods and services services:

U.S. family vacations in Mexico—import of tourism services (debit, funds flow out of U.S.) Foreign student in U.S.—export of education services (credit, funds flow into U.S.)

(2) Net income from abroad (similar to NFP) income receipts from abroad minus income payments to abroad Income received from abroad is a credit item, since it causes funds to flow into the

United States Payment of income to foreigners is a debit item Net income from abroad is part of the current account, and is about equal to NFP, net

factor payments Examples-U.S.:

(1) income from residents working abroad (2) investment income from abroad…interest payments, dividends, royalties, etc.

(3) Net unilateral transfers (similar to NFT) Payments made from one country to another that do not correspond to a good, service,

or asset (if they were, where would they be counted?) Negative net unilateral transfers for United States, since United States is a net donor to

other countries

19-14

Current Account (BOP)

Sum of net exports of goods and services, net income from abroad, and net unilateral transfers is the current account balance Positive current account balance implies

current account surplus Negative current account balance implies

current account deficit Note: Can have CA<0 with NX>0

you can have trade surplus and have massive debt payments (NFP)

19-15

The Rest of the BOP

Capital and Financial Account The capital account part

the net flow of unilateral transfers of assets (debt forgiveness, personal assets migrants take with them, transfer of real estate such as a military base or embassy)

The financial account part trades in existing assets, either real (for example, buildings)

or financial (for example, stocks and bonds) FDI Portfolio

debt equity

19-16

The Rest of the BOP

Note: capital and financial account used to be called capital account…so it’s common to still here people say the “current account and the capital account” “capital account crisis”

Most transactions appear in the financial account

When home country sells assets to foreign country, that is a capital inflow for the home country and a credit (+) item in the capital and financial account

U.S. government sells t-bills to foreigners When assets are purchased from a foreign country,

there is a capital outflow from the home country and a debit (–) item in the capital and financial account

19-17

The Rest of the BOP

Debit (–) Credit () Current Account

Net exports Exports of goods __________ Exports of services __________ Imports of goods __________ Imports of services __________

Net income from abroad (associated with Income receipts from abroad __________ Income payments to foreigners __________

Net unilateral transfers Transfers from foreigners __________ Transfers to foreigners __________

Capital and Financial Account

Capital account __________ Financial account

Increase in foreign-owned assets __________ Increase in domestic-owned assets abroad __________

19-18

The Rest of the BOP

Relationship between the (1) current account and

(2) The capital and financial account Current account balance (CA) + capital and

financial account balance (KFA) = 0 CA + KFA = 0 by accounting; every transaction

involves offsetting effects In practice, measurement problems, recorded as

a statistical discrepancy, prevent CA + KFA = 0 from holding exactly.

19-19

The Rest of the BOP

The official settlements balance Transactions in official reserve assets are conducted by central banks

of countries Official reserve assets are assets (foreign government securities, bank

deposits, and SDRs of the IMF, gold) used in making international payments

Central banks buy (or sell) official reserve assets with (or to obtain) their own currencies

Official settlements balance (1) Also called the balance of payments, it equals the net increase

in a country’s official reserve assets (2) For the United States, the net increase in official reserve assets

is the rise in U.S. government reserve assets minus foreign central bank holdings of U.S. dollar assets

Having a balance of payments surplus means a country is increasing its official reserve assets; a balance of payments deficit is a reduction in official reserve assets

19-20

National Wealth

National Wealth and the balance of payments accounts National Wealth = domestic physical assets + net

foreign assets Net foreign assets (NFA) are a country’s foreign

assets minus its foreign liabilities foreign assets: foreign stocks, bonds, and factories foreign liabilities: domestic and financial assets

owned by foreigners NFA changes due to (1) value change and (2)

through acquisition of new assets or liabilities

NFA2005 = CA 2005 + (1+valuation change)NFA 2004

19-21

National Wealth

A current account surplus implies a capital and financial account deficit, and thus a net increase in holdings of foreign assets a financial outflow…excess savings to the world and getting

in return (1) IOUs, or (2) other assets, or (3) foreign liabilities reduced

A current account deficit implies a capital and financial account surplus, and thus a net decline in holdings of foreign assets a financial inflow…pulling in excess savings from the world

and giving out(1) IOUs, or (2) other assets, or (3) or reducing foreign assets)

International Investment Position = NFA International Investment Position ≠ External Debt

however, large portions of current account deficits are often finance by external debt

19-22

National Wealth

U.S. International Investment Position Largest “debtor” to the world in absolute

dollars ($2.43 trillion, 2003, 22% of GDP) What really matters is not size of net foreign

liabilities but country’s wealth (physical and human capital)

If net foreign liabilities rises and wealth rises, there’s no problem (collateral offsets debt)

U.S. wealth isn’t rising as much as net foreign liabilities which is worrisome

19-23

19-24

NIIP as a Percent of GDP

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

NIIP at Market ValueSource: BEA