Course Description

 International Finance studies the monetary and

macroeconomic relations between countries.
 The course ‘International Finance’ presents the theory
and policy of international finance at a basic level.
 The course covers a broad range of theories in
international finance, including modern exchange rate
theories, open macroeconomic theories and models,
the development of the international monetary
system, and global capital markets, financial and
currency crises
Objective
 The course is designed for undergraduate students at
International Economics and Finance & Banking.
 The course aims to provide students with basic
knowledge, both theoretically and practically.
 Content
 The course is divided into three parts as follows:
 Part I: The determination of the exchange rate in the
short-run and long-run
 Part II: Open macroeconomics and the working of
macroeconomic policies in an open economy.
 Part III: The international monetary system and global
capital markets.
 Content
 Chapter 1: The Balance of Payments and National Income
Accounting
 Chapter 2: Foreign Exchange Market and the Exchange
Rate
 Chapter 3: The Determination of the Exchange Rate: an
Asset-Market Approach
 Chapter 4: The Theory of Purchasing Power Parity (PPP)
and Generalized Model of the Exchange Rate
 Chapter 5: Output and the Exchange Rate in the Short-run
 Chapter 6: Fixed Exchange Rate and Foreign Exchange
Intervention
 Chapter 7: International Monetary System
 Chapter 8: Developing Countries and Financial Crisis
 Required textbooks
 International Economics: Theory and Policy. Ninth
edition. Addison Wesley. (Part III and Part IV, main
textbook)
 Test bank and additional materials.
 Grading Distribution and
Mechanism
 Attendance (5%): All students are expected to attend at
all sessions and participate actively in classroom
discussion.
 In-class contribution (discussions, Q&As, chapter
review, argument etc.) (5%)
 Group case presentation (10%)
 Mid-term exam (20%)
 Final exam (60%)
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Objective
 This chapter discusses the basic concepts of
 the national income accounting
 the balance of payment

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Contents
 National income accounting
 The National Account Identity
 The balance of payment
 Accounting principles
 BOP accounts

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1. National Income Accounting
Gross National Product (GNP)

 GNP is the value of all final goods and services produced by

its production factors and sold on the market in a given
period of time
 GNP is calculated by adding up the value (market value) of
all expenditure on the final output, that consist of
consumption, investment, government consumption and
current account balance

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1. National Income Accounting
Vietnam GDP, 2015
Vietnam GDP, 2015 (Billion VND)
4500000

4000000

3500000

3000000

2500000

2000000

1500000

1000000

500000

0
GDP Đầu tư TD nhà nước TD cá nhân Xuất khẩu ròng Sai số
-500000

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1. National Income Accounting
Vietnam GDP, 2015
Cơ cấu sử dụng GDP 2015 (% GDP)
80.0

70.0

60.0

50.0

40.0

30.0

20.0

10.0

0.0
Đầu tư TD nhà nước TD cá nhân Xuất khẩu ròng Sai số
-10.0

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1. National Income Accounting
Gross National Product (GNP)
In the calculation of GNP, it should be noted that:
➢ Firstly, the value of production inputs are not counted when you
calculate GNP
➢ Secondly, the purchase of used goods is not counted in calculating
the GNP since it does not represent the final goods and services
produced in each period.

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1. National Income Accounting
National product and National Income (ii)
 In principle, the national product must be equal to the national
income since money used to purchase goods and services creates
income for the seller. (or every income must be spent in goods and
services, example with good and services)
 Example with services: when you take the haircut, that purchase of
service enters GNP and the payment is the income of the barber.
 Example with goods: when you purchase a motorcycle, the value of the
motorcycle enters GNP and your payment enters the production factors
that produced the motorcycle, including wages for workers, profits for
the company’s owner and shareholders, parts and other intermediate
inputs used to produce the motorcycle

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1. National Income Accounting
Depreciation and unilateral transfers
 GNP must be adjusted for depreciation and unilateral transfers
so that the identity between national income and national
products is entirely hold in practice.
 Depreciation: depreciation of capital goods reduces the income of
capital owners and must be subtracted from GNP to calculate the
net national product (NNP)
 Income transfers: unilateral transfers from abroad is part of
national income, but not part of national products, and must be
added when calculating national income.

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1. National Income Accounting
Gross Domestic Product GDP
 GDP is the value of all final goods and services produced in a
territory of a country in a given period of time.
 GDP is equal to GNP minus the net receipt of factor incomes from
abroad.
 Net factor income is the income that a country’s residents earn from the
wealth they hold in foreign countries minus the payments they make to
foreign residents for the foreign wealth located at home.
 GDP = GNP – payments from foreign countries for factors of
production + payments to foreign countries for factors of
production
 GDP is a major indicator of economic [Link] movement in
GDP and GNP largely go in line with each other

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2. The Current Account, Savings and Investment
National income accounting for a closed economy (I)
 In a closed economy, there are no exports and imports, and all
national income must be generated by domestic purchase for
private consumption, investment and government purchase
 Consumption is the portion of GNP that households and
individuals purchase to satisfy their current wants.
 Investment is the portion of GNP that is used to produce future
output. Investment consists of fixed investment and inventory
investment.
 Government consumption is the goods and services purchased by
the government for current use, including government spending
on health, education, public administration, road repairs, etc.

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2. The Current Account, Savings and Investment
National income accounting for a closed economy II
 National Accounting Identity for a closed economy:

Y=C+I+G
Y is the national income (GNP),
C is the private consumption
I is the investment
G is the government consumption/purchases

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2. The Current Account, Savings and Investment
National income accounting for an open economy I
 In an open economy, there export and import activities.
 Part of demand for consumption and investment is met by
using goods and services produced abroad (imports),
 Part of domestic output is sold in foreign market (exports)
 The spending on imported goods and services is not part of
a country’s GNP, and must be subtracted in calculation
GNP.
 Domestic goods and services sold in foreign market
(exports) must be added up in calculating GNP.

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2. The Current Account, Savings and Investment
National income accounting for an open economy II
 National income identity for an open economy:

Y = C + I + G + EX - IM
here Y is the national income (GNP), C is the private
consumption; I is the investment; and G is the government
consumption/purchases; EX is exports and IM is imports

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2. The Current Account, Savings and Investment
Current account balance
 The current account balance is the difference between a
country’s exports of goods and services and that country’s
import of goods and services
CA = EX - IM
 Surplus: if exports are greater than imports, a country has a
surplus in the current account
 Deficit: a country is said to have a deficit in the current account
if its imports of goods and services exceeds its export of goods
and services

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2. The Current Account, Savings and Investment
US Current Account as a % of GDP
2%
1%
0%
-1% 1960 1965 1970 1975 1980 1985 1990 1995 2000

-2%
-3%
-4%
-5%
-6%
year
Source: Bureau of Economic Analysis, US Department of Commerce

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2. The Current Account, Savings and Investment
US Current Account 1960-2004
100
billions of current dollars

0
-100 1960 1965 1970 1975 1980 1985 1990 1995 2000

-200
-300
-400
-500
-600
-700
year
Source: Bureau of Economic Analysis, US Department of Commerce

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VIETNAM’S CURRENT ACCOUNT BALANCE

Current Account (% of GDP)

8

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
-2

-4

-6

-8

-10

-12
VIETNAM’S CURRENT ACCOUNT BALANCE
CA (billion USD)
15

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

-5

-10

-15
2. The Current Account, Savings and Investment
Current account and indebtedness
 A deficit in the current account often leads to the increase in
indebtedness. In contrast, a current account surplus reduces a
country’s debt
 When a country experiences a deficit in the current account, it
must finance the deficit by borrowing from foreign countries.
 When a country has a surplus in the current account, it is lending
to its trading partners
 The country’s current account balance is equal to the change in
its net foreign wealth

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2. The Current Account, Savings and Investment
Current account and savings I
 National savings is the portion of national income that is not
used for private and government consumption
 In a closed economy, national savings is equal to national
income minus household consumption and government
consumption
 S=Y–C-G

 In a closed economy, national savings must be equal to national

investment
 S=I

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2. The Current Account, Savings and Investment
Current account and savings II
 Different from a closed economy, an open economy can invest
by using its own savings (national savings) or by acquiring
foreign wealth (foreign savings)
 S = I + CA or I = S – CA
 A deficit in the current account is often referred to as net
foreign investment inflows or foreign savings. By contrast, a
surplus in the current account is often referred to as net
investment abroad

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2. The Current Account, Savings and Investment
Private savings and government savings I
 Domestic savings consist of private savings and government
savings
 Private savings is a portion of household income that is not
used for household consumption. Household disposable
income is the total national income (Yd) minus tax payment (T)
to the government
 SP = Yd - C = Y – T - C

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2. The Current Account, Savings and Investment
Private savings and government savings II

 Government savings is the difference between the government

revenue and its consumption
 Sg = T - G
 Total national savings consist of private savings and
government savings
 S = S p + Sg

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2. The Current Account, Savings and Investment
Private savings and government savings II
 Linkage between private savings, budget deficits, and current
account

 Sp = I + CA + (G - T)
➔This identity shows that private savings can be used to finance
domestic investment and government deficit, and to purchase
foreign assets
 We can write: CA = (Sp - I) + (T - G)

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In-class Exercise
Component Amount (billions of dollars)

Investment, I 760
Net taxes, T 855
Government purchases, G 887
Exports, EX 234
Imports, IM 277

What is the value of net exports?

What is the government sector surplus or deficit?
What is the private saving?
What is the total saving?

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2. The Current Account, Savings and Investment
Currenct Account and budget deficits

US current account and public saving relative to GDP,

1960-2004
4%
2%
Percent of GDP

0%
-2%
-4%
-6%
-8%
1960 1965 1970 1975 1980 1985 1990 1995 2000
current account public saving

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2. The Current Account, Savings and Investment
Currenct Account and budget deficits
Discuss the effects of government deficits on the current
account???
CA = (Sp - I) + (T - G)
 Ricardian Equivalence of taxes and government deficits: when
the government cut taxes and raises deficits, consumer will raise
savings in the anticipation of the increase in future taxes.
 When the government raises taxes and reduces deficits, the private
sector will lower its own savings.
 The change in the budget deficit is offset by the change in private
savings.
 In the late 1990s, the decrease in European countries’ budget
deficits was largely offset by the increase in the private savings.
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3. The Balance of Payment
Balance of payment and economic transactions

 The balance of payment is a record of all economic and

financial transactions between resident organizations and
individuals of a country and its non-residents.

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3. The Balance of Payment
Credit and debit
 International transactions involve the receipt from non-
residents and payments made to foreigners (non-residents)
 The payment made to foreigner is recorded as a debit, and is
given with a negative sign in the balance of payment
 The receipt from foreigners is recorded as a credit, and is given a
positive sign in the balance of payment.
 Each economic transaction is recorded two times in the balance
of payment, one as a debit and the other as a credit (double-
entry bookeeping).

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3. The Balance of Payment
Example of Double entry bookkeeping
 Example 1: A US resident buys a typewriter from an Italian
company and pays for it using check. The Italian company
deposits the receipt at a US bank. The price of the typewriter is
1000 USD
Credit Debit
Typewriter’s purchase, US current account (US -1000
imports of goods)
Sale of the US bank’s deposit (capital account, export +1000
of asset)

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3. The Balance of Payment
Example of Double entry bookkeeping
 Example 2: A US resident buys a share of BP (British
company) with a price of 95 USD. He makes the payment
using his money account at a stock broker. The British
company deposits the receipt from selling the stock at a US
bank.
Credit Debit
Purchase of the BP share, US capital account (US -95
imports of assets)
Deposits by the BP at a US commercial bank +95

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3. The Balance of Payment
Economic Transactions
 Economic transactions between residents and non-residents
consists of three types:
 Current account transactions: these transactions involve exports
and imports of goods and services, factor incomes, and
unilateral transfers.
 Financial account transactions: these transactions arise from the
purchase or sale of financial assets (stocks, bond, money,
factory, deposits).
 Capital account transactions: some special transaction arising
from the nonmarket activities or the acquisition or disposal of
non-produced, non-financial or intangible assets.
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3. The Balance of Payment
The BOP accounts I
 The content of the balance of payments: the balance of
payments consist of three accounts:
➢ The current account
➢ The capital accounts
➢ The financial account

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3. The Balance of Payment
The BOP accounts II
 The current account
➢ The current account involve the transactions in goods and
services, factor incomes and unilateral income transfers
➢ Trade balance: trade balance is the difference between exports
and goods and imports of goods. A country may have a surplus or
deficit in the trade balance
➢ Current account balance: the CA balance is the difference
between the receipt from non-residents (exports of goods and
services, factor incomes and income from unilateral transfers) and
the payments made to foreign non residents (imports of goods and
services, payment of factor incomes to abroad, and unilateral
transfers to foreigners)

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3. The Balance of Payment
The BOP accounts III
 Capital account
➢ The capital account keeps track of the transactions on
special asset and capital
➢ Special assets consist of non-financial and unproduced
assets, such as natural resources or marketing assets
➢ Other capital transfers consist of debt forgiveness,
investment grants, or assets that move with migrants.
➢ The capital account balance is the difference between the
inflows of capital and outflows of capital

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3. The Balance of Payment
The BOP accounts IV
 The financial account records all the transactions
involving financial assets (corporate stocks, bonds,
factories, bank deposits, loans and currencies, etc).
 Financial inflows (capital inflows): the sale of assets to
foreigners is recorded as credits in the financial account.
 Financial inflows involve an increase in foreign assets in a
country or a decrease in the country’s assets held abroad.
 Financial outflows (capital outflows): the purchase of
assets located abroad is recorded as debits in the financial
account.
 Financial outflows involve an decrease in foreign assets in a
country or a increase in the country’s assets held abroad.

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3. The Balance of Payment
The BOP accounts V
 The financial account consist of two components:
➢ Reserve assets: the asset held by monetary authorities
for intervention in the foreign exchange market
(accommodating items).
➢ All other financial investments: transactions arising
from trade and investment activities (autonomous
items)

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3. The Balance of Payment
The BOP accounts VI
 All other financial Investments
 Other financial investments involve the transaction on
other assets not included in the reserve assets or
capital account
➢ Foreign direct investment: inward or outward
➢ Portfolio investment: stocks and bonds
➢ Financial derivatives: futures, options, forward contracts
➢ Other investments: bank deposits and loans, currencies

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3. The Balance of Payment
The BOP accounts VII

 Reserve assets (Official International Reserves)

 The reserve assets are the assets held by the monetary
authorities for finacing the BOP or intervening in the
foreign exchange market.
 Reserve assets includes gold, foreign exchange,..

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3. The Balance of Payment
The BOP Identity
 The balance of payment identity
 Due to the double-entry bookkeeping of each transaction,
the balance of payments accounts will balance by the
following equation:
current account +
financial account +
capital account = 0
The Balance of payments is always balanced."
Discuss

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3. The Balance of Payment
The BOP Identity
 Errors and Omissions
➢ In practice, discrepancies are often observed between the BOP
accounts.
➢ These inconsistencies arise for several reasons: the under-
recording of economic transactions, time inconsistencies, under-
reporting and smuggling…
➢ The difference between the capital account, the financial account,
the current account is considered as statistical errors

28 March 2023 49
3. The Balance of Payment
Official Settlement Balance
 The official settlement balance (the balance of payment) is the sum
of the current account balance, capital account balance and the
financial account balance excluding the changes in reserve assets.
➢ The overall balance may have surplus or deficits. The balance of
payment is said to have a surplus if the overall balance has a
positive sign and vice versa.
➢ The deficit in the balance (excess demand for foreign exchange)
of payment must be financed through the central bank’s
international reserves or central bank borrowing
➢ The surplus in the balance of payment (excess supply of foreign
exchange) would results in the accumulation of the central bank’s
international reserve

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3. The Balance of Payment
The US Balance of Payments 2006 I
Credit Debits
Current Account
(1) Exports 2096.2
Of which:
Goods 1023.1
Services 422.6
Income receipts (primary income) 650.5
(2) Imports -2818.0
Of which:
Goods -1861.4
Services -342.8
Income payments (primary income) -613.8
(3) Net unilateral transfers (secondary income) -89.6
Balance on current account -811.5
[1 + 2 + 3]
Capital Account
(4) Balance on capital account -3.9

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3. The Balance of Payment
The US Balance of Payments 2006 II
Credit Debits
Financial Account
(5) U.S. assets held abroad, excl. financial derivatives -1055.2
Of which:
Official reserve assets 2.4
Other assets -1057.6
(6) Foreign assets held in U.S. , excl. financial derivatives 1859.6
Of which:
Official reserve assets 440.3
Other assets 1419.3
(7) Financial derivatives, net 28.8
Balance on financial account 833.2
[(5) + (6) + (7)]
Net errors and omissions -17.8

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 THANK YOU!

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