Understanding International Macroeconomics: National Income Accounting and Balance of Payments

1. Lectures 1 and 2 National Income Accounting and the Balance of Payments

2. What is International Macroeconomics? • Global macroeconomy • Many monies • Exchange rate behavior • Why do they matter? • Exchange rate crises • Globalization of Finance • Deficits and surpluses

3. What is International Macroeconomics? (cont.) • Debtors and creditors • Government and Institutions • Integration and capital controls • Monetary policy independence

4. Questions we will attempt to answer:examples Dollar’s up and down year Hot Money Roils Growth Currencies The Big Mac Index Currencies and economic cycles How to stop a currency war Saving the Euro

5. Questions: examples (cont.) Don’t do it Baltic Bet

6. 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

7. 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.

8. National Income Accounts: GNP • 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.

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

10. Fig. 12-1: U.S. GNP and Its Components Source: U.S. Department of Commerce, Bureau of Economic Analysis

11. National Income Accounts • GNP is one measure of national income, but a more precise measure of national income is GNP adjusted for following: • Depreciation of physical capital results in a loss of income to capital owners, so the amount of depreciation is subtracted from GNP. • 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

12. Unilateral Transfers in Income • In some countries NUT can be a significant fraction of GNDI • Sometimes this is largely due to foreign aid. • In other cases due to migrant remittances.

13. Are Rich Countries “Stingy”?

14. Are Rich Countries “Stingy”? • Key Findings • In 2003, the U.S. gave double the ODA of the second largest donor, Japan, in dollar terms. • But the U.S. is big. Relative to income, U.S. is at the bottom of the list, officially granting 0.15% of GNI as ODA (13 cents per day, per person). • Still, ODA may be misleading. • Private giving in the U.S. is relatively high (accounts for 60% of giving from the U.S.), but not enough to put the U.S. at the top of the list of donors.

15. Are Rich Countries “Stingy”? • Other “giving” not counted in UN numbers • Debt forgiveness. UN peacekeeping activities. • Global security? Military aid?? Remittances??? • Depends what you mean by giving.

16. Are Rich Stingy? • Lessons • True aid granted by the U.S. may be understated when measured solely in terms of ODA. • It is useful to measure giving in % of GNI terms (to account for the size of the economy) and to identify the sources of aid (public versus private).

17. National Income Accounts (cont.) • 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

18. Celtic Tiger or Tortoise? Trade in factor services explains differences between a country’s GNP and GDP: GNP = GDP + NFIA.

19. Celtic Tiger or Tortoise? • Ireland’s rapid economic growth. • In the early 1970s, Ireland was one of the poorer countries in Europe. • Between 1975 and 2005, real GDP per person grew at 4.4% per year, an exceptional growth rate compared with other rich countries in the European Union. • Who reaped the benefits?

20. Celtic Tiger or Tortoise?

21. Celtic Tiger or Tortoise? • GDP versus GNP. • A sizable portion of this increase in real GDP can be attributed to net factor income from abroad. • While GDP measures Ireland’s production, GNP is the income earned by Ireland.

22. Celtic Tiger or Tortoise? • Interpreting Ireland’s experience. • Countries can rely on factor services from abroad to achieve growth in GDP without growth in GNI. • During this period, Irish GNP per person grew by 3.7%, quite a bit less than the 4.4% growth in GDP per person. • By 2004, Ireland ranked 4th in the OECD by GDP per person, only 17th by GNI per person.

23. Net expenditure by foreign individuals and institutions Expenditure by domestic individuals and institutions GNP = Expenditure on a Country’s Goods and Services Expenditure on domestic production National income = value of domestic production Y = Cd + Id + Gd + EX = (C-Cf) + (I-If) + (G-Gf) + EX = C + I + G + EX – (Cf + If +Gf) = C + I + G + EX – IM = C + I + G + CA

24. Table 12-1: National Income Accounts for Agraria, an Open Economy (bushels of wheat)

25. Understanding the Data • Example: U.S. data for 2006 • TB < 0: C+Y+I > Y Expenditure > Production • NFIA > 0: GNI > GDP Income > Production • NUT < 0: GNI > GNDI Income > Disposable Income

26. Understanding the Data • U.S. trends for Gross National Income (GNP) • Consumption (70%), government consumption (15%), and investment (15%). • Investment fluctuates more than other components.

27. Understanding the Data • U.S. trends for Current Account and Income • U.S. current account deficits have grown time. • Trade balance largest share (–%6 of GNI). • NFIA and NUT are very small in comparison.

28. Expenditure and Productionin 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 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

29. Fig. 12-2: U.S. Current Account and Net Foreign Wealth, 1976–2006 Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2007 release

30. 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 • Y – C – G = I + CA • S = I + CA • CA = S - I

31. How Is the Current Account Related to National Saving? • Current account = national saving – investment • Current account = net foreign investment • A country that imports more than it exports has low national saving relative to investment.

32. How Is the Current Account Related to National Saving? (cont.) CA = S – I or I = S – CA • Countries can finance investment either by saving or by acquiring foreign funds equal to the current account deficit. • a current account deficit implies a financial asset inflow or negative net foreign investment. • When S > I, then CA > 0 so that net foreign investment and financial capital outflows for the domestic economy are positive.

33. Global Imbalances The current account over time.

34. Global Imbalances Savings and investment have declined in industrial countries. U.S. investment demand increased dramatically as the result of a long economic expansion. Savings have declined partially because of rise in the share of the population that is retired. Also wealth accumulation during the housing boom.

35. Global imbalances • Recent experience • U.S. persistent current account deficits since 1990, from declining saving and rising investment. • Japan has experienced persistent current account surpluses since 1980.

36. Global Imbalances • To understand trends in national saving, separate private and government saving. • Private saving is disposable income less consumption: SP = Y – T – C

37. Global imbalances • Government saving is taxes less government consumption: SG = T – G • SG > 0 Government budget surplus • SG < 0 Government budget deficit

38. Global Imbalances • Combing the two types of savings: SP + SG = (Y – T – C) + (T – G) • The expressions above show the possibility of “twin deficits”—a current account deficit associated with a government budget deficit. • Combing the expression above with the current account identity: CA = SP + SG – I

39. Global Imbalances • Government saving is less stable than private saving. • Private savings in the U.S. are relatively low.

40. Global Imbalances • Emerging markets began running current account surpluses in the late 1990s. • Industrialized countries have run current account deficits since the 1990s.

41. Global Imbalances • For the world as a whole, saving and investment have declined as a percentage of GDP. • The current account for the world must be equal to zero. • If one country has a CA deficit, this implies another must have a CA surplus. • The data suffer from errors.