SHAPTER 12 National Income Accounting and the Balance of Payments 301 “European Union (percentage of GNP) Year co Eee 1995 6 259 199 1996 10 246 193 1997 4s 234 194 1998 1.0 26 200 1999 02 21.8 20.8 ‘Source: Organization foe Beotomic Cooperation and Development, OECD Bamamie Outiok 68 (Decensier 2000), sunex ables 21, 30, an 32 (ith nvestent calculate este csi), Bcanomists’ statistical studies suggest, however, that Ricardian equivalence doesn’t hold exactly in practice. Most economists would atiribute no more than half the decline {in Boropean private saving to Ricardian effects, What explains the rest of the decline? ‘The values of European financial assets were generally tising in the Tate 1990s, a devel- ‘opment fueled in part by optimism over the benelicial economic effects of the planned. common currency. tis likely that increased household wealth was @ second factor low- ering the private saving rate in Europe, Because private saving, investiment, the current account, and the government deficit are jointly determined variables, we can never fully determine the cause of a current account change using identity (12-2) alone, Nonetheless, the identity provides an essen {ial framework for thinking about the current account and can furnish useful clues, eae ae ‘l / The Balance of Payments Accounts In addition to national income aecounts, government economists and statisticians also keep balance of payments accounts, « detailed record of the composition of the current account balance and of the many transactions that finance it. Balance of payments figures are of ‘great interest to the general public, as indicated by the attention that various news media pay to them, But press reports sometimes confuse different measures of international payments flows. Should we be alarmed or cheered by 2 Wall Street Journal headline proclaiming “U.S. Chalks Up Récord Balance of Payments Deficit”? A thorough understanding of balance of payments accounting will help us evaluate the implications of a country's international transactions. A country’s balance of payments accounts keep track of both its payments to and its seceipts from foreigners. Any transaction resulting in a payment to foreigners is entered in the balance of payments accounts as a debit and is given a negative (—) sign. Any transaction resulting in « reoeip from foreigners is entered as a credit and is given a positive (+) sign, ‘Thtee types of international transaction are recorded in the balance of payments: 1. Transactions that arise from the export or import of goods or services and therefore eater directly into the current account. When a French consumer imports American biue jeans, for example, the transaction enters the U.S. balance of payments accounts as a credit on current account302 PART THREE Exchange Rates and Open-Economy Macroeconomics 2. Transactions that arse from the purchase or sale of financial assets. An asset is eny one of the forms in which wealth can be beld, such as money, stocks, factories, oF government debt. The finanefal account of the balance of payments records all international purchases or sales of financial assets. When an American company tuys a French factory, the transaction enters the U.S. balance of payments as a debit inthe financial account. Itmay seem strange to givo a negative sign to a purchase of assets and a positive sign toa sale of assets It will seem less so if you think in tsxms ‘of the U.S. “importing” (purchasing) assets andthe U.S. “exposting?” (selling) assets and give the transaction the same sign you would give to an import (~) or export (+) transaction recorded in the current account. The difference between a country’s exports and imports of assets is called its financiel account balance, or financial sccount for shor. 3. Certain other activities resulting in transfers of wealth between countries are recorded in ‘the capital account. These intemational asset movements—which are generally very small for the United States differ from those recorded in the financial account. For the most part they result from nonmarket activities or represent the acquisition or disposal cf nonproduced, nonfinancial, and possibly intangible assets (such as copyrights and tcadomarks). For example, ifthe U.S. govemment forgives $1 billion in debt owed 0 it by the government af Pakistan, U.S. wealth declines by $1 billion and a SI billion debit is recorded in the U.S. capital account. As another example, if a Swede immigrate to the United States and brings with him tite to $100,000 in Swedish assets, the result ‘would be 2 $100,000 credit inthe US. eapitl secount® ‘You will find the complexities of the balance of payments accounts less confusing if you keep in mind the following simple rule of double-entry bookkeeping: Bvery interna tonal transaction automatically enters the balance of payments twice, once asa credit and ‘once asa debit. Tis principle of balance of payments accounting holds true because every ‘transaction has two sides: If you buy something from « foreigner, yoo must pay him in some way, andthe foreigner must then somehow spend or store your payment Examples of Paired Transactions Some examples will show how the principle of double-entry bookkeeping operates in practice, ‘imagine you buy an ink-jet fex machine from the Italian company Oliveti and pay for your purchase with @ $1,000 check. Your payment to buy a good (the fax machine) from & foreign resident enters the U.S. current account with a nogative sign. But where is the off- setting balance of payments credit? Olivetti’s U.S, salesperson must do something with Your check-—Iet's say he depesits it in Olvett's account at Citibank in New York. In this case, Olivetti has purchased, and Citibank has sold, a U.S, asset—a bank deposit worth ‘yp July 1999 the Ute States clasiied ll uansactons else ot caren scount cr capita encoun tmsse= ions, ncuding inthe (ot) capital sccoot the ites hat ae cepted inthe nana account nd incaling 9 the cument soon tema ee n0w psced inte capal escan Thus, tho hypothe example cf debt fogi- ‘nex to Pakistan would have been considered a caveat wanser payment to Pakistan under the ot accounting C3 ‘seconded 0 1 bilion debiin the eurent acount. The motivation forthe chatged accouting format W889 sepa such nonmket nterautionalaset tans, which "mainly represent changes in ownership of exsinB a5, which aft ations balance sheets, fem cients, wich affect natn” inoome and producti ‘cutent period” See Christopher. Bat, “U.S. Intemational Transactions, Revised Estima for 1982-88. Sue) of Currant Businst Jy 199), p. 6SHAFTER 12 National Income Accounting and the Balance of Payments 303 $1,000—and the transaction shows up as 2 $1,000 credit in the U.S. financial account. The transaction creates the following two offseiing bookkexping entries in the U.S, balance of payments Sale of bank deposit by Citibank (Financial account, U.S, asset export) As another example, suppose that during your travels in France you pay $200 fora fine inner at the Restaurant de I'Escargot d’Or. Lacking cash, you place the charge on your ‘Visa credit card. Your payment, which is a tourist expenditure, would be counted as a serv.” ‘ce import for the United States, and therefore as a current account debit. Where isthe off setting credit? Your signature om the Visa slip enticles the restaurant to receive $200 actually, its local cumrency equivalent) from First Card, the company that isstied your Visa ‘card. Itis therefore an asset, a claim on a future payment from First Card. So when you pay for your meal abroad with your credit card, you are selling an asset to France and gencrat- {ng a $200 credit in the U.S, financial account. The pattern of offsetting debits and credits in this case is: ‘Meal purchase (Current account, U.S, service import) Sale of claim on First Card (Financial account, U.S, asset export) +8200 Imagine next that your Uncle Sid from Los Angeles buys a newly issued share of stock in the U.K, oil giant British Petroleum (BP). He places his order with his stockbroker, Go- for-Broke, Inc., paying $95 with a check drawn on his Go-for-Broke money market account. BP, in turn, deposits the $95 dollars Sid has paid in its own U.S. bank account at Second Bank of Chicago. Uncle Sid's acquisition of the stock creates a $95 debit in the U.S. Financial account (he has purchased an asset from a foreign resident, BP), while BP's 895 deposit a its Chicago bank is the offsetting financial account eredit (BP has expanded its U.S. asset holdings). The misrorimage effects on the U.S. balance of payments there- fore both appear in the financial account: Uncle Sid's purchase of a share of BP (Financial account, U.S. asset import) $95 BP's deposit of Uncle Sid's payment at Second Bank of Chicago (Financial account, U.S. asset export) +995 Finally, let’s consider hovr the U.S. balance of payments accounts are affected when U.S. banks forgive (that is, announce that they will simply forget abont) $5,000 in debt owed to them by the government of the imaginary country of Bygonia. In this case, the United States makes a $5,000 capital transfer to Bygonia, which appears as a ~$5,000304 PART THREE Exchange Rates and Open-Eeonomy Macroeconomics : entry in the capital account, The associated credit isin the financial account, in the form of ‘$5,000 reduction in U.S. assets held abroad (a net asset “export,” and therefore a positive balance of payments entry): U.S, banks’ debt forgiveness (Capital account, U.S. transfer payment) Reduction in banks’ claims on Bygonia (Einancial account, U.S. asset export) ‘These examples show that many circumstances can affect the way a transaction gen- crates its offsetting balance of payments entry. We can never predict with certainty where, the flip side-of a particular transaction will show up, but we ean be sure it will show up. somewhere, i The Fundamental Balance of Payments Identity Because any international transaction automatically gives rise to two offsetting entries in the balance of payments, thc current account balance, the financial account balance, zd ‘he capital account balance automatically add up to zero Current account + financial account + capital account = 0, 023) Recall the relationship linking the current account to international lending and borrowing Because the sunt of the current and capital secounts is the total change in @ country’s net foreign assets (including, through the capital account, nonmarket asset (ransfers), that sum necessarily equals the difference between a country’s imports of assets from for- eigners and its exports of assets (o them, that is, the financial account balaace preceded by aminus sign, ‘We now tim to a more detailed description of the balance of payments accounts, using as an example the U.S, accounts for 2006, The Current Account, Once Again ‘As you have learned, the current account balance measures a country's net exports of goods and scrvices. Table 12-2 shows that U.S, exports were $2,096.2 billion in 2006 ‘while U.S. imports were $2,818. billion. Because imports give rise to payments 0 foreigners, they enter the accounts with a negative sign, as shown, ‘The balance of payments accounts divide exports and imports into three finer categories. ‘The fitst is goods trade, that is, exports or imponts of merchandise. The second category services, includes items such as payments for legal esistance, tourists’ expenditures, nd shipping fees. The final category, income, is made up mostly of international interest and dividend payments and the eamings of domestically owned firms operating abroad. If you -own a share of a Germnan firm's stock and receive a dividend payment of $5, that payzteat stows up in the accounts a5 a U.S. investment income receipt of $5. Wages that works ‘eam abroad can also enter the income account, ‘We includé income on foreign investments in the current account becanse that income: seally is compensation forthe services provided by foreign investments. This idea, 23 #6 sa earlier, is behind the distinction between GNP and GDP. When a U.S, corporation builds « plant in Canada, for instance, the productive services the plant generates a viewed as a service export from the United States to Canada equal in value to the profsSHAPTER 12 National Income Accounting and the Balance of Payments 305 Current Account (1) Exports +2,096.2, Of whieh: Goods +1023.1 Services +4226 Income receipts +6505 @) Imports 2,818.0 Of whieh: Goods 1,861.4 Services ~3128 lucome payments 6138 @) Net unilateral evrrent transfers 89.6 Balance on current account sls ()+@+@ Capital Account o 39 Financial Account (5) US. assets held abrond, excluding financial derivatives 1,055.2 increase ~) Of which: Official reserve assets 424 Other assets =1,057.6 (©) Foreign assets heid in U.S, excluding finencial darivatives ——+1,859.6 Gnczease +) Of which: Official eserve assets +4403 Other assets 414193 (1) Financial derivatives, net +288 Balance on financial account +8332 {3+ O+O} Statistical discrepancy -178 {Sum of (1) though (7) with sign reversed] Souree: US. Department of Commee, Bureau of Eeonomie Analysis, Jane 15, 2007, release Totals ay dite rom sums becaus of rounding, the pant yields for its American owner. To be consistent, we must be sure to include these profits in American GNP and not in Canadian GNP, Remember, the definition of GNP refers to goods and services generated by a country’s factors of production, but it does mor specify that those factors must Work within the borders of the country that owns them. Before caloulating the current account, we must include one additional type of interna- ‘ional transaction that we have largely ignored until now, In discussing the relationship between GNP and national income, we defined unilateral transfers between countries as {international gifts, that is, payments that do not correspond to the purchase of any good, service, or asset, Net unilateral transfers are considered part of the current account as well306 PART THREE Exchange Rates and Open-Economy Macroeconomics 48 « past of national income, and the identity Y= C+ 1 + G+ CA holds exactly if ¥) interpreted as GNP plus net transfor, In 2006, the US. balance of unilateral ansfers we ~ $89.6 billion ‘The table shows a 2006 corrent account balance of $2,096.2 billion -$2,818.0 billion $89.6 billion = —$811.5 billion, a deficit. The negative sign means that cusrent payiment excceded current receipts and that U.S. residents used miore output than they producet Since these current account transactions were paid for in some way, we know that this neg ative $811.5 billion entry must be offset by positive $811.5 billion entries in the other tw accounts of the balance of payinents ‘The Capital Account ‘The capital account entry in Table 22-2 shows that in 2006, the United States paid out capita asset transfers of roughly $3.9 billion, These payments by the United States are a belance 0 ‘payments debit that enter with @ negative sign. After we add them to the payments defici implied by the current account, we find thatthe United States’ need 10 cover its excess pay ‘ments to foreigness is raised slightly, from $811.5 billion to $815.4 billion. Because overal USS. foreign receipts must equal foreign payments every year, that —$815.4 billion entry i the U.S. balance of payments must be matched by a +§815.4 billion entry inthe remaining balance of payments account, the financial account, The Financial Account Just as the current account is the difference between sales of goods and services tc foreigners and purchases of goods and services from them, the fnaneiel account measeree the difference between sales of assets to foreigners and purchases of assets located abroad ‘Whea the United States borrows SI from foreigners, itis selling them an asset_-a promise ‘atthey willbe repaid SL, with interest, inthe fture. Such a transaction enter the fuencial account with s positive sign because thé loan i itself payment the United States, ora financial inflow (also sometimes called a capital inflow). When the United States lends abroad, however, a payment is made to forciguers and the capital account is debited, This transaction involves the porchase of an asset from foreigners and is calfed a financial ‘outflow (or, alternatively, a capital ontflow) ‘To cover its 2006 current plus capital account deficit of $815.4 billion, the United States required a nct financial infiow of $815.4 billion. In other words its net bocrow ig or sales of assets to foreigners should have amounted to $815.4 billion. We can look again at “Tbe 12-2 to see exactly how this net financial inflow cane about The table records separately iacreases in U.S, holdings of asscs located abroad which are financial outflows and enter with a negative sign) and increases in foreign holdings ef assets located in the United States (which ae financial inflows and enter with a positive sign). ‘These data oa ineredses in U.S. asset holdings abroad and foreign holdings of U.S, vss not include holdings of financial derivatives, which ate a clas of assets that are more cont. plicatet than ordinary stocks nd bonds, but with values that can depend on stoke and bors’ values. (We will describe some specific dexivative securities in the next chapter.) Starting in 2006, the US. Department of Commerce was able to assemble data on net cross-border Gait ative flows into the United States (foreign net purchases of US.issued derivatives less US. bet purchases of foreign issued derivatives). An increase in such net derivative claims on the ‘United States results ina postive entry inthe US. finanial account According to Table 12:2, U.S -owned assets held abroad (other than derivatives) incrensed by $1,055.2 billion in 2006, contributing @ ~$1,055.2bilion entry to the US, bilance of payments. Foreign-owned assets (other than derivatives) holdin the United States ose bYHAPTER 12 National Income Accounting and the Balance of Payments 307 $1,859.6 billion inthe year, and these purchascs are shown with a positive sign. The balance of US. sales and purchases of financial derivatives was $28.8 billion, again a positive ny. We calculate the balance on financial eocount as $1,859 6 billion —$1,055.2 billion + $28.8 billion = $833.2 billion, a surplus. The Statistical Discrepancy We come out with a financial account surplus of $833.2 billion rather than the smaller {$815.4 billion financial account surplus we expected. If every balance of payments credit automatically generates tn equal counterpart debit, and vice versa, how is this difference possible? The reason is that information aboat the offseting debit and credit items associ ated with given transaction may be collected from different sources. For example, the import debit that a shipment of DVD players from Japan generates may come froma a US. customs inspector's report and the corresponding financial account credit from a report by the U.S, banic in which the check paying for the DVD players is deposited. Because data fiom different sources may differ in coverage, accaracy, and timing, che balance of pay rents accounts seldom balance in practice as they must in theory. Account keepeis force the to sides to balance by adding to the accounts a statistical discrepancy. Kot 2006, unrecorded (or misrecorded) intemational transictions generated a balancing eccounting, debit of ~$17.8 billion, ‘We have no way of knowing exactly how to allocate this discrepancy among the current, capital, and financial accounts. (If we did, it woulda’t be a discrepancy!) The financial account is the most likely culprit, since itis notoriously dificult to keep track of the com- plicated financial trades between residents of different counties. But we cannot conclude ‘iat net financial inflows were $17.8 billion lower than recorded, because the current account is also highly suspect. Balance of payments accountants Consider merchandise twade data celaively reliable, but data on services are not. Service transactions such as sales of financial advice and computer programming assistance may escape detection. Accurate reasurement of international interest and dividend receipts is paticulaly dificult, Official Reserve Transactions Although there are many types of financiel account transaction, one type is important ‘enough to merit separate discussion. This type of transaction is the putchase or sale of official reserve assets by central banks. ‘An economy’s central bank is the institution responsible for managing the supply of roney. In the United States, the central bank is the Federal Reserve System. Official international reserves are foreign assets held by central banks as a cushion against national cconomic misfortune. At one time, offical reserves consisted largely of gold, but ‘today central banks’ reserves include substantial foreign financial assets, particularly U.S. dollar assets such as Treasury bis. The Federal Reserve itself holds only a small level oF official rescrve assets other than gold; its own holdings of U.S, dollar assets are not consid ered international reserves. > ‘Central banks often buy or sel international reserves in private asset markets 10 affect macroeconomic conditions in their economies. Official transactions of this type are called official foreign exchange intervention. One reason why foreign exchange intervention can alter macroeconomic conditions is that it is @ way for the central bank to inject money into the economy or withdravr it from circulation. We will have much more to say Inter abont the causes and consequences of foreign exchange intervention, Government agencies other than central banks may hold foreign reserves and intervene officially in exchange markets. The U.S. Treasury, for example, operates an Exchange308 PART THREE Exchange Rates and Open-Economy Macroeconomics Stabilization Fond that sometimes plays an active role in market trading, Beeanse the ‘operations of such agencies usually have no noticeable impact onthe money supply, how ‘ever, we will simplify our discussion by speaking (when tis is not too misleading) if the central bank alone holds foreign reserves and intervenes. ‘When a central bank purchases or sells a foreign asset, the tansaction appears in its ‘country’s financial account just as if the sare transaction had been carried out by a private citizen. A transection in which the central bank of Tapan (the Bank of Japan) acquires dollar assets might occur as follows: A U.S. anto dealer imports w Nissen sedan from Japan and pays the auto company with a check for $20,000. Nissan does not want to invest the money in dollar assets, but i so happens thatthe Bank of Japan is wiling to give Nissan Japanese money in exchange for the $20,000 check. The Bank of Japan's international reserves rise by $20,000 asa recut ofthe deal. Because the Bank of Japan's dollar reserves are part of total Jepanese assets held in the United States, the Inter rise by $20,000, This transaction therefore results in a positive $20,000 catry in the U.S. financial account, the other side ofthe ~$20,000 entry inthe U.S. curent account du to the import ofthe eax? “Table 12-2 shows the size and direction of official reserve transctions involving the United States in 2006, U.S. official reserve assets—that i, intemational reserves held. by the Federal Reserve—fell by $2.4 billion (evalt chet a positive sign here means a fall in USS.-owned assets held abroad, that is, an “export” of assets to foreigners). Foreign central banks parchased $440.3 billion to add to their reserves. The nc increase in foreign official reserve claims on the United States fess the net increase in U.S, offical reserves is the balance of official reserve transactions, which stood at $440.3 bilion + $2.4 billo {$442.7 billion in 2006. ‘You can think ofthis $442.7 billion balance as measuring the degree to which mone- tary authorities in the United States and abroad joined with other lenders to cover the US. current account deficit. In the example above, the Bank of Japan, by acquiring a $20,000 US. bank deposi, indirectly finances an American impoxt of «$20,000 Fapanese ca. The bookkeeping offset to the balance of official reserve transactions is called the official settlements balance or (in less formal usage) the balanee of payments, This balance is the sum of the current account balance, the capital account balance, the nonteserve ppttion of the financial account balance, and the statistical diserepuncy, and it indicates ‘the payments gap that official reserve transactions need to cover. Thus the US, balance of payments in 2006 was ~$4427 billion, thatis, the balance of official reserve transactions ‘with its sign reversed “The balance of payments played an important historical role as @ measure of disequiib- sium in international payments, and for many countries it stil plays this role. A nepative balance of payments (a dficit) may signal a crisis, for it means that a country is running own its intemational reserve assets or incurring debts to foreign monetary authorities. Ifa country faces the risk of being suddenly cu off from foreign loans it will want to maintain “war chest” of international reserves as a precaution, Developing counties, in particular, are inthis position (see Chapter 22. i Like any summary measure, however, the balance of payments must be interpreted | ‘with canton. To retum’o our running example the Bank of Japan's decision to expandits | US. bank deposit holdings by $20,000 swells the measured U.S, balance of payments] deficit by the same amount, Suppose the Bank of Japan instead places its $20,000 with Barclays Bank in London, which in turn deposits the money with Citibank in New York re tet your undestanag, se you ca explain Why the sume sequence of wtions causes a $20,000mp=0"" | | ' renin doen’ eet att $2000 ws os ol aco |HAPTER 12. National Income Accounting and the Balance of Payments 309 Nonreserve U.S, financial inflows rise by $20,000 in this case, end the U.S, balance of payments deficit does not rise. But this “improvement” in the balance of payments is of litle economic importance: I makes no real diffexeace to the United States whether it borrows the Bank of Japan's money directly or through @ London bark, ‘The Assets and Liabilities of the World’s Biggest Debtor ‘We saw cailicr thatthe current account balance measures te flow of new net lamas on orsign wealth that a country acquires by exporting more goods and services than it jinports This flaw is not, however, the only important factor that causes a county's net forviga wealth to change. In addition, changes inthe market price of wealth previously tcquized can aller a country’s net foreign wealth, When Fapan’s stock mazket lost three {quarters of its value over the 1990s, for example, American and Buropean owners of Japanese sbares saw the value oftheir claims en Japan plummet, atl Japan's et foreign jealth increased asa result. Exchange rate changes have a similar effect. When the dollar deprecates against foreign currencies fer example, foreigners who hold dolat assets se their wealth fall when measured in their home eurtencies “The [urea of Economic Analysis (BEA) of the U.S, Department of Commeree, which oversees the vast job of data collection behind the U.S. national income and bulance ofpavmentssatstics reports snaual estes ofthe nt “iternational investment position” of te United States—the countrys foreign assets les its foreiga liabilities Because assc price and exchange rate changes alter the dollar values of foreign assets ‘and leblies alle, the BEA smust adjst the vals of existing olsims to reflect such septal gains and losses in order to estimate U.S. nat foreign wealth, These estimates Show dia the end of 2006, the United States had a negative net foreign wealth post tion far greater than that of eny other county ‘Until 1991, foreign direct investments (Chapter 7) were valued at t historical, thats, original, purchase prices, Now the BEA uses two diferent methods to place cor tent values on foreign diect investments: the current cast method, which values direct divestments a te cost of buying them today, and the market value method, which is apoant to measote the price at which the investments could be sold, These methods can ead to differnt valuations, because the cost of replacing a particular eect investment fad th price f would command if sold on the mart may be hard to measure. (Fhe net Toveign wealth data graphed in Figure 12-2 are cent cos estinstes) ‘able 12-3 zoproduces the BTAA's account of how it made its valuation adjustments to find the U.S, net foreign postion atthe ond of 2006, This “heudlne” estimate values ttreot investments at current cost, Starting with its estimate of 2005 net forcign wealth (—$2,238.4 billion at current cost), the BEA (colurnn a) subtracted the amount brite 2006 U.S. net financial inflow of $¥33:2 billion —the sum of ines 5,6, and7 in ‘Table 12-2. (De you remember why a financial inflow tothe United States results ina eduction in 0S, net foreign assets?) Then the BEA adjsted the values of previously yell assets and libilities for various changes in thei dollar prices (olumes band. ‘Ae a result ofthese valustion changes, U.S, net foreign wealth fell by aa amount ‘onaller than the $833.2 billion in new net financial inflows from abroad. Based on the unrent cost metbed for valuing direct investments, the BEAN'S 2006 estimate of US, net foreign wealth was —§2,539.6 billion.310 PART THREE Exchange Rates and Open-Economy Macroeconomics Shngmioonin auehm tate HH 7] Saami 35) iE) BR ace ea aera sme) tasers oe firs) eat Teomd esd can aaa ancl tie] ean tt pet {i tat soaniatdenires sadist [Uae mre sls Feathers rcv eit beet anyones om es nn HS et nin ema orcas nd unui aansfasehese sn eyon denen ea nena soe oeerelaath Dutton tnt ee pratt amt bnips sa (Sex yr erect ‘ina tea nu oe oy ees aca a yee tenement aohanna oie oe ‘atte: genes lt nnn lomo esransuns tatters enna eer eae ‘nino ppt tect x oem ‘Ruan antes tu sete tonaaeasoneta ci ‘Reread mnt Ye apni cmt hf ah en 2 Aetna nme ia anneal hn Mm verte arn nnn pe tei coc tomy ea eb ny eee ne sy. air oss nae ery wegen Sm eae Source: U.S. Departinent of Commerce, Bureau of Economie Analysis, Survey of Current Business, July 2007.| Assests, liabilities (ratio to GDP) 14 12 1 08 08 06 02 9 ; 1 Figure 12:3, SHAFTER 12 National Income Accounting and the Balance of Payments 311 Gross foreign labit N Gross fordign assests 976 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2009. 2005 | ies, 1976-2006 "Note: Since 1976, both the foreign assets and the liabiltes ofthe United Stats have Increased sharply, But ails hive risen more ‘quickly leaving the Lnted States witha substantial ne fersign debt, Source: U.S. Department of Commerce, Bureau of Economic Analysis, lune 2007. This debt is larger than the total foteign debt owed by all the Central and Eastern European countries, which was about $750 billion in 2006. To put these figures in per- spective, however, itis important to realize that the U.S. net foreign debt (at market value) amounted to just under 20 percent of its GDP, while that of Hungary, Poland, Romania, and the other Central and Eastern European debtors was about 50 percent of their collec- tive GDP! Thus, the U.S. external debt represents a much lower domestic income drain. ‘Changes in exchange rates and securities prices have the potential to change the U.S. net foreign debt sharply, however, because the gross foreign assets and liabilities of the United States have become so large in recent years. Figure 12-3 illustrates this dramatic ‘trend. In 1976, U.S, foreign assets stood at only 25 percent of U.S. GDP and liabilities at 16 percent (making the United States a net forcign creditor in the amount of roughly 9 percent of its GDP). In 2006, the country’s foreign assets amounted to just under 104 percent of GDP and its liabilities to 123 percent. The tremendous growth in these stocks of wealth reflects the rapid globalization of financial markets in the late 20th century, a phenomenon we will discuss further in Chapter 21. ‘Think about how wealth positions of this magnitude amplify the effects of exchange rate changes, however. Suppose that 70 percent of U.S. foreign assets are denominated in foreign currencies, but that all U.S. liabilities to foreigners are denominated in dollars (these are approximately the correct numbers). Because 2006 U.S. GDP was roughly $13.2 trillion, a 10 percent depreciation of the dollar would leave U.S. liabilities unchanged but would increase U.S, assets (measured in dollars) by 0.1 X 0.7 X LO4 = 7.3 percent of312. PART THREE Exchange Rates and Open-Economy Macroeconomics SUMMARY GDP, or $964 billion. This number is bigger than the entire U.S, current account deficit of 2006! The corresponding redistribution of wealth from foreigners to the United States would have been much smaller back in 1976. Does this possibility mean that policy makers should ignore their countries’ current accounts and instead try to manipulate currency values to prevent large buildups of net foreign debt? That would be a perilous strategy because, as we will see in the next chapter, expectations of future exchange rates are central to market participants’ behavior. Systematic government attempts to teduce foreign investors’ wealth through exchange rate changes would sharply reduce foreigners’ demand for domestic-currency assets, decreasing or eliminating any wealth benefit from depreciating the home currency. 1, International macroeconomics is concerned with the full employment of scarce eco nomic resources and price level stability throughout the world economy. Because thes reflect national expenditure patterns and their intemational repercussions, the nationa income accounts and the balance of payments accounts ate essential tools for studying the macroeconomics of open, interdependent economies. 2. A country’s gross national product (GNP} is equal to the income receivéd by its factors of production. The national income accounts divide national income according to the types of spending that generate it: consumption, investment, government purchases, and the current account balance. Gross domestic product (GDP), equal to GNP less net receipts of factor income from abroad, measures the output produced within a country’s territorial borders. 3. In an economy closed to international trade, GNP must be consumed, invested, or purchased by the government, By using current output to build plant, equipment, and inventories, investment transforms present output into future output. For a closed economy, investment is the only way to save in the aggregate, so the sum of the saving carried out by the private and public sectors, national saving, must equal investment. 4, In an open economy, GNP equals the sum of consumption, investment, government purchases, and net exports of goods and services. ‘Trade does not have to be balanced if the economy can borrow from and Jend to the rest of the world, The difference between the economy's exports and imports, the current account balance, equals the difference between the economy's output and its total use of goods and services. 5. The current account also equals the country’s net lending to foreigners. Unlike a closed economy, an open economy can save by domestic and foreign investment. National saving therefore equals domestic investment plus the current account balance. 6. Balance of payments accounts provide @ detailed picture of the composition and financing of the current account. All transactions between a country and the rest of the ‘world are recorded in its balance of payments accounts. The accounts are based on the convention thet any transaction resulting in a payment to foreigners is entered with @ 1inus sign while any transaction resulting in a receipt from foreigners is entered with a plus sign.