Handout 1: National Income Accounting in Open Economy: The Balance of Payments Flashcards
Unemployment
the problem of ensuring full employment in economies open to international trade
Saving
a country’s saving or borrowing behaviour affects domestic employment and future levels of national wealth (savings are equal to investment in a closed economy, but can be different in an open economy).
Trade imbalances
(the value of exports differs from the value of imports): They redistribute wealth among countries
Money and the Price Level
The supply or demand for money affect both output and employment
National Income Accounting
it records all expenditures that contribute to a country’s income and output
GNP ( word definition)
the value of all FINAL goods and services produced by the factors of production of a country in a given time period. It is calculated by adding up the market value of all expenditures on final output. ( in what follows, GNP is identified with national income).
GDP
the value of final goods and services produced within a country’s borders.
Example: A Spanish firm in the UK: Spain’s GNP but UK’s GDP
GNP ( Equation definition)
GDP + net receipts of factor income from the rest of the world
Expenditure View
divides GNP among its four possible uses:
1) . Consumption
2) . Investment
3) . Government purchases
4) . Current Account Balance CA
Consumption C
The amount consumed by private domestic residents
Investment I
The amount put aside by firms to build new plants and equipment
Government Purchases G
The amount used by the government
Current Account Balance CA
X-M : the amount of net exports of goods and services to foreigners
Closed Economy
Y = C + I + G
so all output produced is consumed or invested ( or added to inventories) by the country’s citizens or purchased by its government.
Open Economy
Y= C + I + G + (X - M)
- X is the value of goods and services exported ( sold to the rest of the world)
- M is the value of goods and services imported ( purchased from the rest of the world)
The Current Account
It represents the value of exports minus the value of imports:
CA = X - M
Current Account Surplus
If CA > 0 ( X>M): The country lends to the rest of the world ( accumulates foreign credit)
Current Account Deficit
If CA < 0 (X < M): the country is borrowing from the rest of the world ( accumulates foreign debt)
National Saving S
The proportion of output that is not devoted to private C or public consumption G
S = Y - C - G
How can a closed economy save?
A closed economy can only save by building its capital stock:
Y= C + I + G => S=I
How can an open economy save?
A open economy can save by building up its capital stock or by acquiring foreign wealth:
Y= C + I + G + CA => S= I + CA
In what type of economy is it possible to increase investment without increasing savings?
In a open economy
What is a open economy’s current account surplus often referred to as?
Net Foreign Investment because a country’s savings can be borrowed by a second country to increase its stock of capital
Private Saving
The part of disposable income saved rather than consumed.
Sp = Y - T - C
Government Saving
T is the net tax revenue
Sg = T - G
National Savings
S*p* + S*g* S =*p* + S*g* = Y -T - C + T -G = Y - C -G = I + CA It can be shown that: S*p* = I + CA + (G-T) S*p* = I + CA - S*g*
Balance of Payments Accounting
It records all transactions between a country and the rest of the world during a time period ( payment to foreigners in debit of the BP ( < 0 ) and receipt from foreigners in credit ( > 0 )
Which three types of transactions are recorded in the Balance of Payments Accounting?
1) . Current Account CA - Transactions that involve goods and services.
2) . Financial Account FA - Transactions that involve financial assets ( any form in which wealth can be held, e.g. money, factories)
3) . Capital Account KA - Transfers of wealth between countries ( non-market activities, e.g. copyrights)
Every transaction enters the balance of balance of payments twice, one as credit and once as debit.
The Fundamental Balance of Payments Identity
CA + FA + KA = 0
The Financial Account
The financial account measures the difference between sales of assets to foreigners and purchases of assets bought abroad.
Non reserve financial account: private transactions ( non-Central Banks)
“private” transactions ( non - Central Banks)
Official Reserve Transactions
Central Bank Transactions
