National Accounts and the Balance of Payments
ECES905205 pertemuan 5
I Made Krisna Gupta
September 19, 2024
Intro
In this chapter, we study economic transactions between countries, how they are undertaken, and what impact they have on the macroeconomy.
The first task of any macroeconomist is to measure economic transactions.
The goals of this chapter are to:
Explain the international system of trade and payments
Discover how international trade in goods and services is complemented and balanced by a parallel trade in assets
Understand how these international transactions relate to national income and wealth
Measuring macro
At various points in the circular flow of payments, a nation’s aggregate economic activity is measured and recorded in the national income and product accounts.
In an open economy, however, such measurements are more complicated because we must account for cross-border flows.
All of these additional flows are recorded in a nation’s balance of payments accounts.
Measuring macro
Gross national expenditure (GNE) is the total expenditure on final goods and services by home entities in any given period. It is made up of three parts: personal consumption C, investment I, and government spending G. GNE = C + I + G
A country’s gross domestic product (GDP) is the value of all (intermediate and final) goods and services produced as output by firms, minus the value of all goods and services purchased as intermediate inputs by firms.
In a closed economy, income is paid to domestic entities. It thus equals the total income resources of the economy, also known as gross national income (GNI).
Measuring macro
The Closed Economy Measurements of national expenditure, product, and income are recorded in the national income and product accounts, with the major categories shown. The purple line shows the circular flow of all transactions in a closed economy.
Open economy
The difference between payments made for imports and payments received for exports is called the trade balance (TB), which equals net payments to domestic firms due to trade.
GNE plus TB equals GDP, the total value of production in the home economy.
The value of factor service exports minus factor service imports is known as net factor income from abroad (NFIA), and thus GDP plus NFIA equal GNI, the total income earned by domestic entities from all sources, domestic and foreign.
Open economy
Gifts may take the form of income transfers or “in kind” transfers of goods and services.
They are considered nonmarket transactions, and are referred to as unilateral transfers.
Net unilateral transfers (NUT) equals the value of unilateral transfers the country receives from the rest of the world minus those it gives to the rest of the world.
Open economy
These net transfers have to be added to GNI in order to calculate gross national disposable income (GNDI).
Thus, GNI plus NUT equals GNDI, which represents the total income resources available to the home country.
Open economy
The current account (CA) is a tally of all international transactions in goods, services, and income (occurring through market transactions or transfers).
Asset side
The value of asset exports minus asset imports is called the financial account (FA).
These net asset exports are added to home GNDI when calculating the total resources available for expenditure in the home country.
A country may not only buy and sell assets but also transfer assets as gifts.
Such asset transfers are measured by the capital account (KA), which is the value of capital transfers from the rest of the world minus those to the rest of the world.
Open economy
The Open Economy Measurements of national expenditure, product, and income are recorded in the national income and product accounts, with the major categories shown on the left. Measurements of international transactions are recorded in the balance of payments accounts, with the major categories shown on the right. The purple line shows the flow of transactions within the home economy. The green lines show all cross-border transactions.
Three approach
The expenditure approach looks at the demand for goods: It examines how much is spent on demand for final goods and services. The key measure is GNE.
The product approach looks at the supply of goods: It measures the value of all goods and services produced as output minus the value of goods used as inputs in production. The key measure is GDP.
The income approach focuses on payments to owners of factors: It tracks the amount of income they receive. The key measures are gross national income (GNI) and gross national disposable income (GNDI) (which includes net transfers).
Expenditures
Personal consumption expenditures (usually called “consumption”) equal total spending by private households on final goods and services. This includes nondurable goods (e.g., food), durable goods (e.g., autos), and services.
Gross private domestic investment (usually called “investment”) equals total spending by firms or households on final goods and services to make additions to the stock of capital. This includes construction of a new house or factory, the purchase of new equipment, and net increases in inventories of goods held by firms (i.e., unsold output).
Expenditures
Government consumption expenditures and gross investment (often called “government consumption”) equal spending by the public sector on final goods and services. This includes spending on public works, national defense, the police, and the civil service. It does not include any transfer payments or income redistributions, e.g., Social Security or unemployment insurance payments—these are not purchases of goods or services, just rearrangements of private spending power.
GNE GDP
GDP=C+I+G⏟GNE+(X−M)⏟Trade Balance
The trade balance (TB), also referred to as net exports, may be positive (trade surplus) or negative (trade deficit).
GNI
Gross national income equals gross domestic product (GDP) plus net factor income from abroad (NFIA).
GNI=C+I+G⏟GNE+(X−M)⏟Trade Balance⏟GDP+(EXFS−IMFS)⏟NFIA
GDP vs GNI
Indonesia?
GNI GNDI
A country which engage in in kind transfer has Net Unilateral Transfer (NUT), so that:
Y⏟GNDI=C+I+G⏟GNE+(X−M)⏟TB+(EXFS−IMFS)⏟NFIA⏟GNI+(UTIN−UTOUT⏟NUT)
For some country, NUT can be very large. e.g., in West Bank and Gaza, NUT is around 31% of GNI.
National account
Y⏟GNDI=C+I+G⏟GNE+(X−M)⏟TB+(EXFS−IMFS)⏟NFIA+(UTIN−UTOUT⏟NUT⏟Current Account (CA))
On the left is our full income measure, GNDI.
The first term on the right is GNE, which measures payments by home entities.
The remaining terms measure net payments to the home country from all international transactions in goods, services, and income. We group the three cross-border terms into an umbrella term that is called the current account (CA).
National account, Indonesia, 2022
| Category | Symbol | Trillions of Rp |
|---|---|---|
| Consumption | C | 10,390 |
| Investment | I | 6,998 |
| Government | G | 1,505 |
| Gross National Expenditure | GNE | 18,893 |
| Trade Balance | TB | 693 |
| Gross Domestic Product | GDP | 19,586 |
| Net factor income from abroad | NFIA | -538 |
| Gross national income | GNI | 19,048 |
| Net unilateral transfers | NUT | 5 |
| Gross national disposable income | GNDI | 19,053 |
Indonesian GNE & TB
Current account
Y=C+I+G+CA
This equation is the open-economy national income identity. It tells us that the current account represents the difference between national income Y (or GNDI) and gross national expenditure GNE (or C + I + G). Hence:
GNDI is greater than GNE if and only if CA is positive, or in surplus.
GNDI is less than GNE if and only if CA is negative, or in deficit.
Current account
The current account is also the difference between national saving (S = Y − C − G, by definition) and investment:
S⏟Y−C−G=I+CA
This equation, often written as CA = S – I , is called the current account identity even though it is just a rearrangement of the national income identity.
S > I if and only if CA is positive, or in surplus.
S < I if and only if CA is negative, or in deficit.
Saving-investment
Current account balance (CAB) is simply the difference between Domestic saving (GSav) and investment (Gross Capital Formation, GCF) in Indonesia.
Meanwhile in Japan, saving rate keeps decreasing since 1970. However, Japan constantly see saving>investment (surplus CAB) with notable exceptions.
Saving-investment
USA constantly has higher GCF compared to its saving rate. Meaning, US sees a constant CAD (current account deficit) which seems to be increasing in 2000s.
China, meanwhile, see a constant CA surplus with no notable decrease in saving rate (like Japan), but instead tend to go up (like Indonesia)
CAB
This graph shows current account balance of the 4 countries. Indonesia sees a surplus during the commodity boom, but overall moves around. China and Japan sees a constant surplus while the US a constant deficit. Japan and China = net creditors, USA = net debtor.
Global imbalances
- We define private saving (Sp) as that part of after-tax private sector disposable income Y that is not devoted to private consumption C
Sp=Y−T−C
- We define government saving (Sg) as the difference between tax revenue T received by the government and government spending G.
Sg=T−G
- It gives us the national saving S=Sp+Sg
Global imbalances
By definition, government saving is the government budget surplus (T−G).
Government deficit sometimes goes together with CAD (“twin deficit”), but not always.
CA=Sp+Sg+I
Ricardian equivalence assets that a fall in Sg will be offset by a rise in Sp.
This theory is unproven empirically.
The financial account
The financial account (FA) records transactions between residents and nonresidents that involve financial assets. This definition covers all types of assets:
Real assets such as land or structures
Financial assets such as debt (bonds, loans) or equity issued by any entity
Subtracting asset imports from asset exports yields the home country’s net overall balance on asset transactions, which is known as the financial account, where FA=EXA−IMA.
The financial account therefore measures how the country accumulates or decumulates assets through international transactions.
The Capital Account
The capital account (KA) covers two remaining areas of asset movement, both of minor quantitative significance:
- Capital transfers (i.e., gifts of assets), an example of which is the forgiveness of debts
- The acquisition and disposal of nonfinancial, nonproduced assets (e.g., patents, copyrights, trademarks)
We denote capital transfers received by the home country as KAIN vcand capital transfers given by the home country as KAOUT. The capital account, KA=KAIN−KAOUT, denotes net capital transfers received, and is typically small in magnitude.
Balance of Payments
- From the home perspective, a foreign asset is a claim on a foreign country.
- When a home entity holds such an asset, it is called an external asset of the home country.
- From the foreign perspective, a foreign asset is a claim on the home country.
- When a foreign entity holds such an asset, it is called an external liability of the home country because it represents an obligation owed by the home country to the rest of the world.
Double entry
| no | example | sym | value |
|---|---|---|---|
| 1 | CA: drinks in Paris bar | −IM | -$110 |
| FA: Bar’s claim on AMEX | EXHA | +$110 | |
| 2 | CA: Arkansas wine exported to Denmark | EX | +$36 |
| CA: Jutland wine imported to United States | −IM | -$36 | |
| 3 | FA: George’s French tech stocks | −IMFA | -$10,000 |
| FA: BNP claim against Citibank | +EXHA | +$10,000 | |
| 4 | CA: Relief supplies exported to Bam | +EX | +$5,000 |
| CA: George’s charitable gift | −UTOUT | -$5,000 | |
| 5 | KA: US grant of debt relief | −KAOUT | -$1,000,000,000 |
| FA: Decline in US external assets | +EXFA | +$1,000,000,000 |
Home and foreign asset
- Let “H” denote the home asset and “F” the foreign asset.
FA=(EXHA−IMFA)−(EXFA−IMHA)=(EXHA−IMHA)−(IMFA−EXFA)
FA equals the additions to external liabilities (home-owned assets moving into foreign ownership, net) minus the additions to external assets (foreign-owned assets moving into home ownership, net).
Macro view
- Recall that gross national disposable income is
Y=GNDI=GNE+TB+NFIA+NUT=GNE+CA
which is resources available to home country from income.
- But the home economy can also free up resources by sales (or purchases) of assets. We calculate these extra resources using our previous definitions:
EXA−IMA+KAIN−KAOUT=FA+KA
which is extra resources available to home country due to all asset trades.
Macro view
- Adding the last two expressions, we have the value of the total resources available to the home country for expenditures. This total value is equal to total value of home expenditure on final goods and services, GNE
GNE+CA⏟Resources from income+FA+KA⏟Resources from asset trade=GNE
- cancelling GNE from both sides we get BOP Identity:
CA+KA+FA=0
BOP Identity
- The component of the bOP identity shows why the accounts must balance
CA=(EX−IM)+(EXFS−IMFS)+(UTIN−UTOUT)KA=(KAIN−KAOUT)FA=(EXHA−IMHA)+(EXFA−IMFA)
- If an item has a plus sign, it is called a BOP credit.
- If an item has a plus sign, it is called a BOP debit.
BOP Identity
We have to understand one simple principle: Every market transaction (whether for goods, services, factor services, or assets) has two parts.
If party A engages in a transaction with a counterparty B, then A receives from B an item of a given value, and in return B receives from A an item of equal value.
BOP Indonesia
See SEKI table V.1
BOP Indonesia
Understanding BOP
A country with a current account surplus is a (net) lender.
By the BOP identity, it must have a deficit in its asset accounts.
Any lender, on net, buys assets (acquiring IOUs from borrowers). For example, China is a large net lender.
A country with a current account deficit is a (net) borrower.
By the BOP identity, it must have a surplus in its asset accounts.
Any borrower, on net, sells assets (issuing IOUs to lenders). As we saw, the U.S. is a large net borrower.
Understanding BOP
The balance of payments accounts consist of:
The current account, which measures external imbalances in goods, services, factor services, and unilateral transfers
The financial and capital accounts, which measure asset trades
Surpluses on the current account side must be offset by deficits on the asset side. Deficits on the current account must be offset by surpluses on the asset side.
The balance of payments makes the connection between a country’s income and spending decisions and the evolution of that country’s wealth.
External wealth
Just as a household is better off with higher wealth, all else equal, so is a country.
“Net worth” or external wealth with respect to the rest of the world (ROW) can be calculated by adding up all of the ROW assets owned by the home country and then subtracting all of the home assets owned by the ROW.
In 2015, the United States had an external wealth of about –$7,357 billion.
This made the United States the world’s biggest debtor in history at the time of this writing.
Indonesia? -$-376 billion in 2015 and -$261 billion in 2023 (SEKI table V.39)
External wealth
External wealth⏟W=ROW assets owned by home⏟A−Home assets owned by ROW⏟L
A country’s level of external wealth is also called its net international investment position or net foreign assets. It is a stock measure, not a flow measure.
If W>0, home is a net creditor country: external assets > external liabilities.
If W<0, home is a net debtor country: external assets < external liabilities.
Changes in W
There are two reasons a country’s level of external wealth changes over time.
Financial flows: As a result of asset trades, the country can increase or decrease its external assets and liabilities. Net exports of home assets cause an equal increase in the level of external liabilities and hence a corresponding decrease in external wealth.
Valuation effects: The value of existing external assets and liabilities may change over time due to capital gains or losses. In the case of external wealth, this change in value could be due to price effects or exchange rate effects.
Changes in W
ΔW=−FA+Capital gains
From BOP Identity: −FA=CA+KA, thus
ΔW=CA+KA+Capital gains
External wealth
Without valuation effects, previous equation implies that ΔW should equal the cumulative net import of assets overtime.
However, valuation effects (i.e., capital gains) can generate a significant difference in external wealth.
In the US since 1988, valuation effects reduced US net external indebtedness by almost 20% in 2015 compared with the level financial flows alone would have predicted.
In Indonesia this effect is understudy and you cannot see it in the SEKI table V.39 alone.
External wealth
External wealth data tell us the net credit or debit position of a country with respect to the rest of the world.
They include data on external assets (foreign assets owned by the home country) and external liabilities (home assets owned by foreigners).
A creditor country has positive external wealth; a debtor country has negative external wealth.
Countries with a current account surplus (deficit) must be net buyers (sellers) of assets.
External wealth
An increase in a country’s external wealth results from every net import of assets; conversely, a decrease in external wealth results from every net export of assets.
In addition, countries can experience capital gains or losses on their external assets and liabilities that cause changes in external wealth.
All of these changes are summarized in the statement of a country’s net international investment position.
National Accounts and the Balance of Payments ECES905205 pertemuan 5 I Made Krisna Gupta September 19, 2024