INTERNATIONAL FINANCE
COURSE CODE: B6932MI
TOPIC 2
National Income Accounting and the
Balance of Payments
After having studied this topic, the student should
be able to:
• Discuss the concept of the current account
balance.
• Use the current account balance to extend
national income accounting to open economies.
• Apply national income accounting to the
interaction of saving, investment, and net
exports.
National Income Accounting and the
Balance of Payments
• Describe the balance of payments accounts
and explain their relationship to the current
account balance.
• Relate the current account to changes in a
country’s net foreign wealth.
The National Income Accounts
• Of central concern to macroeconomic analysis is
a country’s gross national product (GNP), the
value of all final goods and services produced by
the country’s factors of production and sold on
the market in a given time period.
• GNP, which is the basic measure of a country’s
output studied by macroeconomists, is calculated
by adding up the market value of all expenditures
on final output.
The National Income Accounts (Cont.)
• GNP therefore includes the value of goods like
bread sold in a supermarket and textbooks sold in
a bookstore as well as the value of services
provided by stock brokers and plumbers.
• Because output cannot be produced without the
aid of factor inputs, the expenditures that make
up GNP are closely linked to the employment of
labor, capital, and other factors of production.
The National Income Accounts (Cont.)
There are four different types of expenditure
that make up a country’s GNP and are as
follows:
• Consumption (the amount consumed by
private domestic residents).
• Investments (the amount put aside by private
firms to buy equipment/build new plant for
future production).
The National Income Accounts (Cont.)
• Government purchases (the amount used by
the government).
• Current account balance (the amount of net
exports of goods and services to foreigners).
• By dividing GNP into consumption,
investment, government purchases and the
current account, help us to understand the
cause of a particular recession or boom of a
country.
The National Income Accounts (Cont.)
• And without such an understanding, we
cannot recommend a sound policy response.
• In addition, the national income accounts
provide information essential for studying why
some countries are rich – that is, have a high
level of GNP relative to population size, while
some are poor.
Capital Depreciation and
International Transfers
• GNP does not take into account the economic
loss due to the tendency of machinery and
structures to wear out as they are used.
• This loss, called depreciation, reduces the
income of capital owners.
• To calculate national income over a given
period, we must therefore subtract from GNP
the depreciation of capital over the period.
Capital Depreciation and
International Transfers (Cont.)
• GNP less depreciation is called net national
product (NNP).
• A country’s income may include gifts from
residents of foreign countries, called unilateral
transfers.
• Examples of unilateral transfers of income are
pension payments to retired citizens living
abroad, reparation payments, and foreign aid
such as relief funds donated to drought-stricken
nations (e.g. donations received by Office of
Prime Minister).
Capital Depreciation and
International Transfers (Cont.)
• Net unilateral transfers are part of a country’s
income but are not part of its product, and
they must be added to net national product
(NNP) in calculations of national income.
• National income equals GNP less depreciation
plus net unilateral transfer.
Gross Domestic Product (GDP)
• Most countries have long reported gross
domestic product (GDP) rather than GNP as
their primary measure of national economic
activity.
• GDP is supposed to measure the volume of
production within a country’s borders,
whereas GNP equals GDP plus net receipts of
factor income from the rest of the world.
The Balance of Payments Accounts
• A country’s balance of payments accounts
keep track of both its payments to and from
its receipts from foreigners.
• Any transaction resulting in a receipt from
foreigners is entered in the balance of
payments accounts as a credit.
• Any transaction resulting in a payment to
foreigners is entered as a debit.
The Balance of Payments Accounts
(Cont.)
Three types of international transaction are
recorded in the balance of payment are as follows:
(1) Transactions that arise from the export or
import of goods or services and therefore enter
directly into the current account.
(2) Transactions that arise from the purchase or sale
of financial assets. An asset is any one of the
forms in which wealth can be held, such as
money, stocks, factories or government debt.
The Balance of Payments Accounts
(Cont.)
The financial account of the balance of payments
records all international purchases or sales of
financial assets.
(3) Certain other activities resulting in transfers of
wealth between countries are recorded in the
capital account. These international asset
movements – for the most part they result from
nonmarket activities or represent the acquisition or
disposal of nonproduced, nonfinancial, and possibly
intangible assets (such as copyrights and
trademarks).
The Current Account
• The current account balance measures a
country’s net exports of goods and services.
The balance of payments accounts divide
exports and imports into three finer categories.
(1) Goods trade, that is, exports and imports of
merchandise.
(2) Services, includes items such as payments for
legal assistance, tourists’ expenditures, and
shipping fees.
The Current Account (Cont.)
(3) Income – is made up mostly of international
interest and dividend payments and the
earnings of domestically owned firms operating
abroad.
The Financial Account
• The financial account measures the difference
between acquisitions of assets (e.g. stocks and
bonds) from foreigners and the buildup of
liabilities to them.
Capital Account
• The capital account consists of capital
transfers and the cross-border acquisition and
disposal of non-produced non-financial assets
such as natural resources and market assets.
Official Reserve Account
• The official reserve account – covers all
purchases and sales of international reserve
assets such as dollars, foreign exchange, gold,
and special drawing rights (SDRs).