National Income Accounting and the

Balance of Payments

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Learning Objectives
13.1 Discuss concept of current account balance.
13.2 Use the current account balance to extend national
income accounting to open economies.
13.3 Apply national income accounting to the interaction
of saving, investment, and net exports.
13.4 Describe balance of payments accounts and explain
their relationship to the current account balance.
13.5 Relate the current account to changes in a country’s
net foreign wealth.

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Preview
• National income accounts
– measures of national income
– measures of value of production
– measures of value of expenditure
• National saving, investment, and the current account
• Balance of payments accounts

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The National Income Accounts (1 of 5)
• Records the value of national income that results from
production and expenditure.
– Producers earn income from buyers who spend
money on goods and services.
– The amount of expenditure by buyers =
the amount of income for sellers =
the value of production.
– National income is often defined to be the income
earned by a nation’s factors of production.

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The National Income Accounts (2 of 5)
• Gross national product (GNP) is the value of all final
goods and services produced by a nation’s factors of
production in a given time period.
– What are factors of production? Factors that are used
to produce goods and services: workers (labor
services), physical capital (like buildings and
equipment), natural resources and others.
– The value of final goods and services produced by
US-owned factors of production are counted as US
GNP.

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The National Income Accounts (3 of 5)
• GNP is calculated by adding the value of expenditure on
final goods and services produced:
1. Consumption: expenditure by domestic consumers
2. Investment: expenditure by firms on buildings &
equipment
3. Government purchases: expenditure by governments on
goods and services
4. Current account balance (exports minus imports): net
expenditure by foreigners on domestic goods and
services

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Figure 13.1 U.S. GNP and Its
Components

America’s gross national product for the first quarter of 2016 can be broken down
into the four components shown.
Source: U.S. Department of Commerce, Bureau of Economic Analysis. The figure
shows 2016:QI GNP and its components at an annual rate, seasonally adjusted.
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The National Income Accounts (4 of 5)
• GNP is one measure of national income, but a more
precise measure of national income is GNP adjusted for
following:
1. Depreciation of physical capital results in a loss of
income to capital owners, so the amount of depreciation
is subtracted from GNP.
2. Unilateral transfers to and from other countries can
change national income: payments of expatriate
workers sent to their home countries, foreign aid and
pension payments sent to expatriate retirees.

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The National Income Accounts (5 of 5)
• Another approximate measure of national income is
gross domestic product (GDP):
– Gross domestic product measures the final value of
all goods and services that are produced within a
country in a given time period.
– GDP = GNP − payments from foreign countries for
factors of production + payments to foreign countries
for factors of production

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National Income Accounting for an Open
Economy (1 of 2)
• The national income identity for an open economy is

Y = C + I + G + EX − IM
= C + I + G + CA
– where C + I + G is expenditure by domestic individuals
and institutions
– and CA is net expenditure by foreign individuals and
institutions

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National Income Accounting for an Open
Economy (2 of 2)
CA = EX − IM = Y − (C + I + G )
• When production > domestic expenditure, exports >
imports: current account > 0 and trade balance > 0
– when a country exports more than it imports, it earns
more income from exports than it spends on imports
– net foreign wealth is increasing
• When production < domestic expenditure, exports <
imports: current account < 0 and trade balance < 0
– when a country exports less than it imports, it earns
less income from exports than it spends on imports
– net foreign wealth is decreasing
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Table 13.1 National Income Accounts for
Agraria, an Open Economy (bushels of wheat)

GNP Government
= Consumption + Investment + + Exports − Imports
(total output) purchases

100 = 75a + 25 + 10 + 10 − 20b

a55 bushels of wheat + (0.5 bushel per gallon) × (40 gallons of milk).
b0.5 bushel per gallon × 40 gallons of milk.

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Saving and the Current Account
• National saving (S) = national income (Y) that is not spent
on consumption (C) or government purchases (G).
S=Y−C−G
• An open economy can save by building up its capital stock
or by acquiring foreign wealth.
S = I + CA

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Private and Government Saving
• Private saving is the part of disposable income (national
income, Y, minus taxes, T) that is saved rather than
consumed:
S P  Y T  C
• Government saving is net tax revenue, T, minus
government purchases, G:
Sg  T G

• Private and government saving add up to national saving.

S  Y T  C   T  G   S P  S g

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Figure 13.2 The U.S. Current Account and Net
International Investment Position, 1976–2015

A string of current account deficits starting in the early 1980s reduced America’s
net foreign wealth until, by the early 21st century, the country had accumulated a
substantial net foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
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Balance of Payments Accounts (1 of 2)
• A country’s balance of payments accounts accounts for its
payments to and its receipts from foreigners.
• An international transaction involves two parties, and each
transaction enters the accounts twice: once as a credit (+)
and once as a debit (−).

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Balance of Payments Accounts (2 of 2)
• The balance of payments accounts are separated into 3
broad accounts:
– current account: accounts for flows of goods and
services (imports and exports).
– financial account: accounts for flows of financial
assets (financial capital).
– capital account: flows of special categories of
assets (capital): typically nonmarket, non-produced,
or intangible assets like debt forgiveness, copyrights
and trademarks.

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Examples of Balance of Payments
Accounting (1 of 4)
• You import a fax machine from Olivetti.
• Olivetti deposits your check in a U.S. bank.

Fax machine purchase (Current account, U.S. good import) −$1,000

Sale of bank deposit (Financial account, U.S. asset sale) +$1,000

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Examples of Balance of Payments
Accounting (2 of 4)
• You buy lunch in France and pay by credit card.
• French restaurant receives payment from your credit card
company.

Meal purchase (Current account, U.S. service import) −$200

Sale of credit card claim (Financial account, U.S. asset sale) +$200

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Examples of Balance of Payments
Accounting (3 of 4)
• You buy a share of BP.
• BP deposits the money in a U.S. bank.

Stock purchase (Financial account, U.S. asset purchase) −$95

Bank deposit (Financial account, U.S. asset sale) +$95

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Examples of Balance of Payments
Accounting (4 of 4)
• U.S. banks forgive a $5,000 debt owed by the government
of Bygonia through debt restructuring.
• U.S. banks who hold the debt thereby reduce the debt by
crediting Bygonia’s bank accounts.

U.S. banks debt forgiveness (capital account, U.S. transfer

−$5,000
payment)
Reduction in bank’s claims on Bygonia (financial account,
+$5,000
U.S. asset sale)

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How Do the Balance of Payments
Accounts Balance?
• Due to the double entry of each transaction, the balance of
payments accounts will balance by the following equation:
current account + financial account + capital account = 0

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Balance of Payments Accounts (1 of 7)
The 3 broad accounts are more finely divided:
• Current account: imports and exports
1. merchandise (goods like DVDs)
2. services (payments for legal services, shipping
services, tourist meals, etc.)
3. income receipts (interest and dividend payments,
earnings of firms and workers operating in foreign
countries)

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Balance of Payments Accounts (2 of 7)
• Current account: net unilateral transfers
– gifts (transfers) across countries that do not purchase
a good or service nor serve as income for goods and
services produced
• Capital account: records special transfers of assets, but
this is a minor account for the U.S.

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Balance of Payments Accounts (3 of 7)
• Financial account: the difference between sales of domestic
assets to foreigners and purchases of foreign assets by domestic
citizens.
• Financial inflow
– Foreigners loan to domestic citizens by buying domestic
assets.
– Domestic assets sold to foreigners are a credit (+) because
the domestic economy acquires money during the transaction.
• Financial outflow
– Domestic citizens loan to foreigners by buying foreign assets.
– Foreign assets purchased by domestic citizens are a debit (−)
because the domestic economy gives up money during the
transaction.
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Balance of Payments Accounts (4 of 7)
• Financial account has at least 3 subcategories:
1. Official (international) reserve assets
2. All other assets
3. Statistical discrepancy

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Balance of Payments Accounts (5 of 7)
• Statistical discrepancy
– Data from a transaction may come from different
sources that differ in coverage, accuracy, and timing.
– The balance of payments accounts therefore seldom
balance in practice.
– The statistical discrepancy is the account added to or
subtracted from the financial account to make it
balance with the current account and capital account.

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Balance of Payments Accounts (6 of 7)
• Official (international) reserve assets: foreign assets held
by central banks to cushion against financial instability.
– Assets include government bonds, currency, gold, and
accounts at the International Monetary Fund.
– Official reserve assets owned by (sold to) foreign central
banks are a credit (+) because the domestic central
bank can spend more money to cushion against
instability.
– Official reserve assets owned by (purchased by) the
domestic central bank are a debit (−) because the
domestic central bank can spend less money to cushion
against instability.

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 Balance of Payments Accounts (7 of 7)
• The negative value of the official reserve assets is called
the official settlements balance or “balance of payments”.
– It is the sum of the current account, the capital account,
the nonreserve portion of the financial account, and the
statistical discrepancy.
– A negative official settlements balance may indicate that
a country
 is depleting its official international reserve assets, or
 may be incurring large debts to foreign central banks
so that the domestic central bank can spend a lot to
protect against financial instability.

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Table 13.2 U.S. Balance of Payments
Accounts for 2015 (billions of dollars)

Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 16,

2016, release. Totals may differ from sums because of rounding.
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U.S. Balance of Payments Accounts (1 of 2)
• The U.S. has the most negative net foreign wealth in the
world, and so is therefore the world’s largest debtor nation.
• Its current account deficit in 2012 was $440 billion dollars,
so that net foreign wealth continues to decrease.
• The value of foreign assets held by the U.S. has grown
since 1980, but liabilities of the U.S. (debt held by
foreigners) has grown faster.

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Figure 13.3 U.S. Gross Foreign Assets and
Liabilities, 1976-2015

Since 1976, both the foreign assets and the liabilities of the United States have
increased sharply. But liabilities have risen more quickly, leaving the United States
with a substantial net foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2016.
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U.S. Balance of Payments Accounts (2 of 2)
• About 70% of foreign assets held by the U.S. are
denominated in foreign currencies and almost all of U.S.
liabilities (debt) are denominated in dollars.
• Changes in the exchange rate influence value of net
foreign wealth (gross foreign assets minus gross foreign
liabilities).
– Appreciation of the value of foreign currencies makes
foreign assets held by the U.S. more valuable, but
does not change the dollar value of dollar-
denominated debt for the U.S.

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Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of
dollars) (1 of 4)

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Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of
dollars) (2 of 4)

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Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of
dollars) (3 of 4)

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Table 13.3 Change in the Yearend U.S. Net
International Investment Position (billions of
dollars) (4 of 4)

r Revised n.a. Not available. . . . Not applicable (*) Value between zero and +/− $50 million
1. Represents gains or losses on foreign-currency-denominated assets and liabilities due to their revaluation at current
exchange rates.
2. Includes changes due to year-to-year shifts in the composition of reporting panels and to the incorporation of more
comprehensive survey results. Also includes capital gains and losses of direct investment affiliates and changes in
positions that cannot be allocated to financial transactions, price changes, or exchange-rate changes.
3. Financial transactions and other changes in financial derivatives positions are available only on a net basis, which is
shown on line 3; they are not separately available for gross positive fair values and gross negative fair values of
financial derivatives.
4. Data are not separately available for price changes, exchange-rate changes, and changes in volume and valuation not
included elsewhere.
Note: Details may not add to totals because of rounding.
Source: U.S. Bureau of Economic Analysis.

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Summary (1 of 3)
1. A country’s GNP is roughly equal to the income
received by its factors of production.
2. In an open economy, GNP equals the sum of
consumption, investment, government purchases,
and the current account.
3. GDP is equal to GNP minus net income from foreign
countries for factors of production. It measures the
value of output produced within a country’s borders.

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Summary (2 of 3)
4. National saving minus domestic investment equals the current
account (≈ exports minus imports).
5. The current account equals the country’s net foreign
investment (net outflows of financial assets).
6. The balance of payments accounts records flows of goods &
services and flows of financial assets across countries.
– It has 3 parts: current account, capital account, and financial
account, which balance each other.
– Transactions of goods and services appear in the current
account; transactions of financial assets appear in the
financial account.

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Summary (3 of 3)
7. Official international reserve assets are a component of
the financial account, which records official assets held
by central banks.
8. The official settlements balance is the negative value of
official international reserve assets, and it shows a central
bank’s holdings of foreign assets relative to foreign
central banks’ holdings of domestic assets.
9. The U.S. is the largest debtor nation, and its foreign debt
continues to grow because its current account continues
to be negative.

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Copyright

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