Lecture Notes 1 National Income Accounting and Balance of Payments

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Lecture notes 1 national income accounting and balance of

payments
International Macroeconomics (香港中文大學)
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ECON3620
INTERNATIONAL
MACROECONOMICS
Andy Chung

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Teaching Team
• Instructor: Andy Chung
• Office: ELB 1002
• Email: chunkitchung@cuhk.edu.hk
• Office Hours: by appointment

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Teaching Team
• Teaching Assistants
• Chen Junlin
• Email: chenjunlin@link.cuhk.edu.hk
• Zhang Yiran
• Email: zhangyiran@link.cuhk.edu.hk

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Course Description
• The main topics of this course are: international
financial markets, the determination of exchange
rates, the relation between exchange rates and
inflation, and monetary and fiscal policy under
flexible and fixed exchange rates. This course gives
students frameworks and analytical tools to think
about these topics and apply them to the real
world. It will also touch on a number of relevant
current issues. Students should have knowledge of
elementary differential calculus, and are advised to
take ECON2011 and 2021 before taking this
course.

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Learning Outcomes & Honesty in

Academic Work
• Upon successful completion of the course, students
should be able to understand some simple causal
relationships between international macroeconomic
events and the reasons why some policies can or
cannot be used to deal with some economic
problems.
• Students must observe the University's policy on

Honesty in Academic Work
http://www.cuhk.edu.hk/policy/academichonesty/

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Course Requirements
• 60% Two problem sets (30% each; to be submitted in
weeks 6 and 12, the deadline will be announced later, NO late
submission will be allowed for any reasons)
• 40% Final Exam (centrally scheduled by the University)

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Readings
Main Textbooks
Krugman, Obstfeld, and Melitz,
International Economics: Theory
and Policy, 11th Edition (K)
Schmitt-Grohé (S), Uribe, and

Woodford, International
Macroeconomics, available
online:
http://www.columbia.edu/~mu216
6/UIM/index.html (S)
Supplementary reference
Freenstra and Taylor, International
Economics (F)

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Syllabus
Topics Required readings
1 National Income Accounting and the Balance K 13
of Payments
2 Current Account: Intertemporal Choice S2&3
Approach
3 Exchange Rates and the Foreign Exchange K 14
Market: An Asset Approach
4 Money, Interest Rates, and Exchange Rates K 15
5 Price Levels and the Exchange Rate in the K 16
Long Run
6 Output and the Exchange Rate in the Short K 17
Run
7 Fixed Exchange Rates and Foreign Exchange K 18
Intervention
8* International Monetary Systems: An K 19
Historical Overview
9* Financial Globalization: Opportunity and K 20
Crisis
10* Optimum Currency Areas and the Euro K 21

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Chapter 1
National Income Accounting and the
Balance of Payments

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Learning Objectives
1. Discuss concept of current account balance.
2. Use the current account balance to extend national
income accounting to open economies.
3. Apply national income accounting to the interaction of
saving, investment, and net exports.
4. Describe balance of payments accounts and explain
their relationship to the current account balance.
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

• 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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• 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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• 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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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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• 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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Hong Kong 2018 GDP

3,000,000 2,845,317
2,500,000
1,945,011
2,000,000
HK$ (million)
1,500,000
1,000,000
617,223
500,000
280,797
2,286
0
GDP (at Private Government investment Exports -
current consumption consumption Imports
market price) expenditure expenditure
Source: Census and Statistics Department, HKSAR [accessed: Nov 2019]

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Hong Kong 2018 Current Account

6,000,000
4,457,931
4,000,000
2,000,000
HK$ (million)
892,259
2,286
0
-635,923
-2,000,000
-4,000,000
-4,711,981
-6,000,000
Exports - exports of export of imports of imports of
Imports goods services goods services

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National Income Accounting for an Open

Economy
• 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
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 (i.e. net lending to foreign countries) 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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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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The World’s Biggest Debtor

• 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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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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The World’s Biggest Debtor

• 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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Net International Investment Position

• Net international investment position: the country’s foreign assets less its foreign
liabilities
2018 Net International Investment Position (millions of US dollars)

4,000,000 3,081,336
2,130,090
2,000,000 1,294,339
412,861
0
-284,474 -380,925
-2,000,000
-4,000,000
-6,000,000
-8,000,000
-10,000,000
-9,554,711
-12,000,000
US UK Euro Area HKSAR Mainland Japan South Korea
China
Source: IMF [accessed: Nov 2019]

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Saving and the Current Account

• By definition, national saving (S) = national income (Y) that
is not spent on consumption (C) or government purchases
(G).
S=Y−C−G
• In a closed economy, national saving must equal
investment
S=I
• 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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Private and Government Saving

• Since S = SP + Sg = I + CA, we have
SP = I + CA + (G – T)
• A country’s private saving can take three forms:
1. Investment in domestic capital
2. Purchases of wealth from foreigners
3. Purchases of the domestic government’s newly issued
debt

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Balance of Payments Accounts

• 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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• 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): an asset is any one of the
forms in which wealth can be held, like money,
stocks, factories or government debt.
– capital account: flows of special categories of
assets (capital): typically nonmarket, non-produced,
or intangible assets such as debt forgiveness.

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Examples of Balance of Payments

Accounting
• You import a fax machine from a foreign country, pay by check.
• The foreign seller has a claim against a local bank, an export of
local asset to the foreign country.
Import of foreign good (Current account, local good import) debit $1,000
Export of local asset (Financial account, local asset sale) credit $1,000

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Accounting
• You buy lunch in France and pay by credit card.
• French restaurant receives payment from your credit card
company (a sale of credit card claim).
Import of foreign good and services (Current account, local

debit $200
service import)
Export of local asset (Financial account, local asset sale) credit $200

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Accounting
• You buy a new share of a foreign company, pay in check.
• The foreign company has a claim against a local bank, an
export of local asset to the foreign country.
Import of foreign asset (Financial account, local asset

debit $95
purchase)
Export of local asset (Financial account, local asset sale) credit $95

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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 + capital account = financial account

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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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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)
• net unilateral transfers
– gifts (transfers) across countries that do not purchase a good
or service nor serve as income for goods and services
produced

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• 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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• Financial account has at least 3 subcategories:
1. Official (international) reserve assets
2. All other assets
3. Statistical discrepancy
• Capital account: records special transfers of assets, but
this is a minor account for the U.S.

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• Official (international) reserve assets: foreign assets
purchased by central banks to cushion against financial
instability.
– Assets include government bonds, currency, gold, and
accounts at the International Monetary Fund.
– Official reserve assets sold to foreign central banks are a
credit.
– Official reserve assets purchased by the domestic central
bank are a debit.
– The net value of the official reserve assets is called the
official settlements balance or “balance of payments”.

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• 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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Hong Kong Balance of Payments

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Lecture notes 1 national income accounting and balance of

Scan to open on Studocu

Studocu is not sponsored or endorsed by any college or university

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Learning Outcomes & Honesty in

• Students must observe the University's policy on

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Schmitt-Grohé (S), Uribe, and

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

Downloaded by Randhir kumar (rhnof151@gmail.com)

The National Income Accounts

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The National Income Accounts

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The National Income Accounts

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U.S. GNP and Its Components

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The National Income Accounts

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Hong Kong 2018 GDP

Source: Census and Statistics Department, HKSAR [accessed: Nov 2019]

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Hong Kong 2018 Current Account

Source: Census and Statistics Department, HKSAR [accessed: Nov 2019]

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National Income Accounting for an Open

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National Income Accounting for an Open

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The U.S. Current Account and Net

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The World’s Biggest Debtor

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U.S. Gross Foreign Assets and Liabilities,

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The World’s Biggest Debtor

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Net International Investment Position

2018 Net International Investment Position (millions of US dollars)

Source: IMF [accessed: Nov 2019]

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Saving and the Current Account

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Private and Government Saving

• Private and government saving add up to national saving.

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Private and Government Saving

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Balance of Payments Accounts