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Chapter 12 Supplementary Notes expenditure on production Net expenditure by foreigners Domestic expenditure GNP = Expenditure on a Country’s Goods and Services Y = C d + I d + G d + EX = ( C-C f ) + ( I-I f ) + ( G-G f ) + EX

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Chapter 12 l.jpg

Chapter 12

Supplementary Notes


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expenditure

on production

Net expenditure

by foreigners

Domestic

expenditure

GNP = Expenditure on a Country’s Goods and Services

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

National income = value of

production



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Imports and Exports As a Fraction of GDP

Imports and exports as a percentage of GDP by country, 2000. Source: OECD


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GNP and GDP

  • Gross domestic product measures the final value of all goods and services that are produced within a country in a given time period.

  • GNP = GDP + factor payments from foreign countries - factor payments to foreign countries

  • GNP = GDP + net factor income from abroad


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Expenditure and Productionin an Open Economy

CA = EX – IM = Y – (C + I + G )

  • When production > domestic expenditure, exports > imports: current account > 0, 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, 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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surplus

deficit

US Current Account As a Percentage of GDP, 1960–2004



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US Current Account and Net Foreign Wealth, 1977–2003


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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).

    Y – C – G

    = (Y – C – T) + (T – G)

     S = Sp + Sg

  • National saving = private saving + govt saving


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How Is the Current Account Related to National Saving?

CA = Y – (C + I + G )

 CA = (Y – C – G ) – I

CA = S – I

current account = national saving – investment

current account =net foreign investment

Note: I is domestic investment

  • A country that exports more than it imports invests in foreign countries (by lending the CA surplus to foreigners).


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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 or negative net foreign investment implies a financial capital inflow (through international borrowing).


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How Is the Current Account Related to National Saving? (cont.)

CA = Sp + Sg – I

= Sp – GD – I

  • GD, Government deficit (= G – T), is negative govt saving

  • A high government deficit causes a negative current account balance, all other things equal.


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Inverse Relationship Between (cont.)Public Saving and Current Account?

Source: Congressional Budget Office, US Department of Commerce


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Balance of Payments Accounts (cont.)

  • A country’s balance of payments accounts record its payments to and its receipts from foreigners.

  • Record all international transactions in goods, services, assets

    Services: travel, transportation, royalties, etc.

    Assets: bank loans, deposits, stocks, bonds, etc.




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3 Broad Accounts (cont.)

  • The balance of payment 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 non-market, non-produced, or intangible assets like debt forgiveness, copyrights and trademarks.


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Credit and Debit (cont.)

  • Double-entry bookkeeping: Each international transaction enters the BoP accounts twice: once as a credit (+) and once as a debit (-).

  • Credit: sale of domestic goods, services, assets to foreigners

  • Debit: purchase of foreign goods, services, assets from foreigners


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Some useful tips (cont.)

  • Credit: we sell to foreigners

  • Debit: we buy from foreigners

  • Treat payment as if we sell the financial assets (e.g., deposits). Receipts are treated as if our purchase of financial assets.

  • The payment part is recorded on the other side of the BoP table.

  • Exceptions: unilateral transfers, debt forgiveness


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Example 1 (cont.)

  • You import a DVD of Japanese anime by using your debit card.

  • The Japanese producer of anime deposits the funds in its bank account in San Francisco. The bank credits the account by the amount of the deposit.


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Example 2 (cont.)

  • You invest in the Japanese stock market by buying $500 in Sony stock.

  • Sony deposits your funds in its Los Angeles bank account. The bank credits the account by the amount of the deposit.


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Example 3 (cont.)

  • US banks forgive a $100 M debt owed by the government of Argentina through debt restructuring.

  • US banks who hold the debt thereby reduce the debt by crediting Argentina's bank accounts.


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More Terms (cont.)

  • Private financial transactions include direct investment, portfolio investment (security purchases), and bank claims and liabilities.

  • Financial transactions are also classified either short-term or long-term. Long-term means maturity longer than or equal to 1 year.

  • “Official” means assets treated as foreign reserves. They include foreign currencies, gold, Special Drawing Rights, and reserve position at the IMF.

  • Balance of payments = current a/c + capital a/c + non-reserve financial a/c


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Capital inflow and outflow (cont.)

  • Financial (capital) inflow

    • Foreigners loan to domestic citizens by acquiring domestic assets.

    • Foreign owned (sold) assets in the domestic economy are a credit (+)

    • A surplus on the financial account implies net inflow of foreign capital.

  • Financial (capital) outflow

    • Domestic citizens loan to foreigners by acquiring foreign assets.

    • Domestically owned (purchased) assets in foreign economies are a debit (-)

    • A deficit on the financial account implies net outflow of foreign capital.


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