National Income Accounting

and The Balance of Payments

Introduction
 Is a trade deficit bad for an economy?
 How is the trade balance part of a
larger economic picture?
 What is the role of imports and exports
in an economy?
 What are a country’s balance of
payments and their role in the
economy?
Balance of Payments
 Important component of GDP
 Changes in components influence economic
performance in short run
 As trade becomes a larger proportion of GDP,
it will have a greater impact on short run
performance
 Country’s interaction with world affects
country’s production of goods/services as well
as financial markets
National Income Accounting
 Calculation of GDP and subdivision of
GDP
 Imports and exports are a part of GDP but
also related to other components
 Relationships between components of
GDP and exports/imports help interpret
effects of economic events
Measurement of GDP
 GDP – market value of all final good and
services produced in a country in a given
period of time
 Total output measured in country’s currency
with goods/services measured at market
prices
 Not all transactions are accounted for
 Constant changes in prices must be
considered for comparison across time
Exclusions from GDP
 Intermediate goods
 Only final goods/services - Value added by all
inputs
 Value of a desk, not value of wood in desk
 Non-reported market transactions and
activities
 Homemakers
 Tax evasion, illegal goods
 GDP is understated – conservative estimate of
country’s total economic activity
Changes in Prices
 Current prices can distort measure of
real output
 A doubling of prices doubles value of
GDP
 Does not mean twice the amount of
goods/services were produced
 Are increase in GDP from increases in
prices or quantity of goods?
Real v. Nominal GDP
 Nominal GDP
 Value of final output measured in current
prices
 Real GDP
 Market value of goods and services
produced within a period of time adjusted
to changing prices – measured in base year
prices
Real GDP over Time
Components of GDP
 Summation of expenditures by different
components of country
 Consumption (C)
 Gross Private Domestic Investment (I)
 Government spending on goods/services
(G)
 Net Exports (NX) = Exports (X) – Imports
(M)
Components of GDP
Components of GDP
 Consumption is approximately 68% of
GDP
 Investment approximately 19%
 Government spending approximately
17%
 Net Exports approximately -4%
 Imports are greater than exports
Imports and Exports - US
GDP and Trade Balance
 Closed Economy (no trade)
GDP = C + I + G
 Open Economy
GDP = C + I + G + (X - M)
 Trade Surplus
 X > M  (X - M) > 0
 Trade Deficit
 X < M  (X - M) < 0
Imports, Exports & GDP
 Open Economy Equation
X–M=Y-C-I-G
 Where Y = GDP
 Trade surplus or deficit is residual of
what is produced and consumed in
domestic economy
 C, I, and G  demand for domestically
produced output by sectors of economy
Imports, Exports & GDP
 Imports make up for excess demand
 Trade Deficit
 Exports make up for excess supply
 Trade Surplus

Country Y C I G X-I
A 9224 6258 1173 1573 -220
B 5134 3089 1464 506 75
Imports, Exports & GDP
 A trade deficit means a country is
increasing it indebtedness to other
countries
 Trade balance is a flow variable –
occurs over a period of time
 Amount of debt a country has is a stock
variable – set at a period in time
Imports, Exports & GDP
 Trade surplus means a country is reducing its
indebtedness to other countries
 Accumulating more claims on foreign
countries
 Trade surplus and deficit measure mismatch
between domestic production and domestic
consumption
 Not necessarily true that a surplus is better
Intertemporal Trade
 A trade deficit is importing present
consumption
 Deficits must be paid by producing more than
consuming – exporting future consumption
 Trade deficit is the process of importing
present consumption and exporting future
consumption
 Trading of production and consumption is
intertemporal trade
Intertemporal Trade
 A trade surplus is exporting present
consumption to other countries
 Future trade deficits are importing future
consumption
 Trade imbalances denote a country’s
preference for present versus future
consumption
 Preferences expressed by choices of consumers,
government, and businesses
Government Budget
 GDP measures current income
 Income to factors of production
 Wages, rent, interest, profit
 Public spends income on goods/services
 Money moves in circular flow from
businesses to public and back
GDP – Current Income
 Leakage of Income
 Income temporarily withdrawn from flow
 Savings (S), Government taxes (T),
Imports (M)
 Injections of Income
 Activities that bring money back into flow
 Investment (I), Government Spending (G),
Exports (X)
GDP – Current Income
 Investment potential offset for outflow
of savings
 Government spending potential offset
for outflow of government taxes
 Exports potential offset for outflow or
imports
GDP – Current Income
 Sum of outflows must equal sum of inflows
S+T+M=G+I+X
 This does not mean S=I or T=G or X=M
 Rearranging
X–M=S–I+T–G
 Trade balance mismatch between private
saving (S), government saving (T-G) and
business saving (I)
GDP – Current Income
 When outflows (S+T) are greater than
spending injections (G+I), trade balance (X-
M) is positive
 When outflows are less than injections, trade
balance is negative
 Trade balance is difference between outflows
of income and domestic injections of
spending
X – M = (S + T) - (I + G)
Trade Imbalance
 Reduction of trade imbalance
 Produce more goods/services than
consume
 Increasing production in short run difficult
 Reduce domestic spending in short run
 Not appealing solution
Strategies – Reduce Imbalance
 Given X - M = S – I + T – G
 A country has four strategies to reduce
imbalance
 Table 10.2 examines each strategy
Methods to Reduce Imbalances
Strategies – Reduce Deficit
1. Increase S – savings
 Decline in savings rate from 1970s – 1980s has
contributed to US trade deficit
 Difficult to implement policies to increase
savings
2. Decrease I – investment
 Potential GDP growth linked to increase in I
 Short run strategy to decrease I could lead to
long run decline in economic growth
Strategies – Reduce Deficit
3. Increase T – taxes
 Reduces government budget deficit or
produces a surplus
 Similar to increasing level of saving
4. Reduce government spending
 More effect if combined with increases in
taxes
 More certain than increasing S and more
desirable than reducing I
Strategies – Reduce Surplus
1. Decrease Savings which increases
consumption
2. Increase investment which also
increase long run growth potential
3. Increasing government spending or
decreasing taxes
 Reduce government budget surplus or
increase size of deficit
Balance of Payments Accounts
Balance of Payments Accounts
Balance on Current Account
Balance on Current Account
 Merchandise Trade Balance (Trade Balance)
 Difference between merchandise exports

and imports
 From table 10.4, US has a merchandise

trade deficit of -$452.2 billion

 US is net importer of merchandise
Merchandise Trade Balance
Balance on Current Account
Balance on Current Account
 Services payments include tourism
 In 2001, service exports were $293.4 billion
including
 Travel and transportation services provided by US
to foreigners
 Fees and royalties in US received from foreigners
 Imports were $217.0 billion
 Balance on services was $76.4 billion –
surplus in services
Balance on Current Account
Balance on Current Account
Balance on Current Account
Balance on Current Account
Balance on Current Account
 Unilateral transfers can be outflows or
inflows
 US has consistent negative net of unilateral
transfers to and from foreigners
 Current Account
 Balance on goods, services, income, and
unilateral transfers
 Most comprehensive view of a country’s
total trade flows
Current Account
Balance on Capital Account
Balance on Capital Account
Balance on Capital Account
 Change in foreign assets
 Records all purchases of US assets by foreigners
and foreign central banks
 Create an inflow of money from abroad – positive
number
 Balance on capital account records the net of
inflows and outflows for all capital account
transactions
 Was $443.3 billion in 2001
Merchandise Trade Balance
Current
Account Deficit
$100 -100
$-200

Capital
Account

$100 Surplus
+100
Current
Account Deficit
$1000 $-2000 $-1000
Exports Imports

Capital
Account

$1000 Surplus
+1000
BALANCE OF PAYMENT MUST ZERO UP

 $1000 Current Account Surplus

 $-1000 Capital Account Deficit

 $-1000 Current Account Deficit

 $1000 Capital Account Surplus

 Balance of Payment must zero up

Current and Capital Account
 Total inflows and outflows must equal
 Current account and capital account
must balance out
 Negative current account means capital
account must be positive
 A deficit on trade in goods/services must
be “financed” by borrowing from foreigners
Current and Capital Account
 US has been financing current account deficit
by borrowing from rest of world and selling
US assets
 Deficit in goods/services must be offset
somewhere else in balance of payments
through
 Investment income
 Inflows of capital
 Positive unilateral transfers
Current and Capital Account
 Surpluses must be balanced as well
 Current account surplus means a capital
account deficit
 Less capital for investors to invest in own
country
 Growth may slow in future
 Exporting capital may lower rate of growth of
productivity and growth of real wages
 May lead to rising investment income