National Income Accounting
and the Balance of Payments
Between 2004 and 2007, the world economy boomed, its total real product
growing at an annual average rate of about 5 percent per year. The growth
rate of world production slowed to around 3 percent per year in 2008, before
dropping to minus 0.6 percent in 2009—a reduction in world output unprecedented
in the period since World War II. These aggregate patterns mask sharp differences
among individual countries. Some, such as China, slowed relatively modestly in
2009, while the output of other countries, such as the United States, contracted
sharply. Can economic analysis help us to understand the behavior of the global
economy and the reasons why individual countries’ fortunes often differ?
Previous chapters have been concerned primarily with the problem of making
the best use of the world’s scarce productive resources at a single point in time.
The branch of economics called microeconomics studies this problem from the
perspective of individual firms and consumers. Microeconomics works “from the
bottom up” to show how individual economic actors, by pursuing their own interests,
collectively determine how resources are used. In our study of international
microeconomics, we have learned how individual production and consumption
decisions produce patterns of international trade and specialization. We have also
seen that while free trade usually encourages efficient resource use, government
intervention or market failures can cause waste even when all factors of production
are fully employed.
With this chapter we shift our focus and ask: How can economic policy
ensure that factors of production are fully employed? And what determines how
an economy’s capacity to produce goods and services changes over time? To
answer these questions, we must understand macroeconomics, the branch of
economics that studies how economies’ overall levels of employment, production,
and growth are determined. Like microeconomics, macroeconomics is
concerned with the effective use of scarce resources. But while microeconomics
focuses on the economic decisions of individuals, macroeconomics analyzes
the behavior of an economy as a whole. In our study of international macroeconomics,
we will learn how the interactions of national economies influence the
worldwide pattern of macroeconomic activity.
part three Exchange Rates and Open-Economy Macroeconomics
294 PART THREE Exchange Rates and Open-Economy Macroeconomics
Macroeconomic analysis emphasizes four aspects of economic life that, until
now, we have usually kept in the background to simplify our discussion of international
economics:
1. Unemployment.We know that in the real world, workers may be unemployed
and factories may be idle. Macroeconomics studies the factors that cause
unemployment and the steps governments can take to prevent it. A main concern
of international macroeconomics is the problem of ensuring full employment
in economies open to international trade.
2. Saving. In earlier chapters we usually assumed that every country consumes an
amount exactly equal to its income—no more and no less. In reality, though,
households can put aside part of their income to provide for the future, or they
can borrow temporarily to spend more than they earn. A country’s saving or
borrowing behavior affects domestic employment and future levels of national
wealth. From the standpoint of the international economy as a whole, the
world saving rate determines how quickly the world stock of productive capital
can grow.
3. Trade imbalances. As we saw in earlier chapters, the value of a country’s
imports equals the value of its exports when spending equals income. This
state of balanced trade is seldom attained by actual economies, however. In
the following chapters, trade imbalances play a large role because they redistribute
wealth among countries and are a main channel through which one
country’s macroeconomic policies affect its trading partners. It should be no
surprise, therefore, that trade imbalances, particularly when they are large
and persistent, quickly can become a source of international discord.
4. Money and the price level. The trade theory you have studied so far is a
barter theory, one in which goods are exchanged directly for other goods on
the basis of their relative prices. In practice, it is more convenient to use
money—a widely acceptable medium of exchange—in transactions, and to
quote prices in terms of money. Because money changes hands in virtually
every transaction that takes place in a modern economy, fluctuations in the
supply of money or in the demand for it can affect both output and employment.
International macroeconomics takes into account that every country
uses a currency and that a monetary change (for example, a change in
money supply) in one country can have effects that spill across its borders to
other countries. Stability in money price levels is an important goal of international
macroeconomic policy.
This chapter takes the first step in our study of international macroeconomics by
explaining the accounting concepts economists use to describe a country’s level of
production and its international transactions. To get a complete picture of the
macroeconomic linkages among economies that engage in international trade, we
have to master two related and essential tools. The first of these tools, national
income accounting, records all the expenditures that contribute to a country’s
income and output. The second tool, balance of payments accounting, helps us
CHAPTER 13 National Income Accounting and the Balance of Payments 295
keep track of both changes in a country’s indebtedness to foreigners and the
fortunes of its export and import-competing industries. The balance of payments
accounts also show the connection between foreign transactions and national
money supplies.
LEARNING GOALS
After reading this chapter, you will 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.
• 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.
and the Balance of Payments
Between 2004 and 2007, the world economy boomed, its total real product
growing at an annual average rate of about 5 percent per year. The growth
rate of world production slowed to around 3 percent per year in 2008, before
dropping to minus 0.6 percent in 2009—a reduction in world output unprecedented
in the period since World War II. These aggregate patterns mask sharp differences
among individual countries. Some, such as China, slowed relatively modestly in
2009, while the output of other countries, such as the United States, contracted
sharply. Can economic analysis help us to understand the behavior of the global
economy and the reasons why individual countries’ fortunes often differ?
Previous chapters have been concerned primarily with the problem of making
the best use of the world’s scarce productive resources at a single point in time.
The branch of economics called microeconomics studies this problem from the
perspective of individual firms and consumers. Microeconomics works “from the
bottom up” to show how individual economic actors, by pursuing their own interests,
collectively determine how resources are used. In our study of international
microeconomics, we have learned how individual production and consumption
decisions produce patterns of international trade and specialization. We have also
seen that while free trade usually encourages efficient resource use, government
intervention or market failures can cause waste even when all factors of production
are fully employed.
With this chapter we shift our focus and ask: How can economic policy
ensure that factors of production are fully employed? And what determines how
an economy’s capacity to produce goods and services changes over time? To
answer these questions, we must understand macroeconomics, the branch of
economics that studies how economies’ overall levels of employment, production,
and growth are determined. Like microeconomics, macroeconomics is
concerned with the effective use of scarce resources. But while microeconomics
focuses on the economic decisions of individuals, macroeconomics analyzes
the behavior of an economy as a whole. In our study of international macroeconomics,
we will learn how the interactions of national economies influence the
worldwide pattern of macroeconomic activity.
part three Exchange Rates and Open-Economy Macroeconomics
294 PART THREE Exchange Rates and Open-Economy Macroeconomics
Macroeconomic analysis emphasizes four aspects of economic life that, until
now, we have usually kept in the background to simplify our discussion of international
economics:
1. Unemployment.We know that in the real world, workers may be unemployed
and factories may be idle. Macroeconomics studies the factors that cause
unemployment and the steps governments can take to prevent it. A main concern
of international macroeconomics is the problem of ensuring full employment
in economies open to international trade.
2. Saving. In earlier chapters we usually assumed that every country consumes an
amount exactly equal to its income—no more and no less. In reality, though,
households can put aside part of their income to provide for the future, or they
can borrow temporarily to spend more than they earn. A country’s saving or
borrowing behavior affects domestic employment and future levels of national
wealth. From the standpoint of the international economy as a whole, the
world saving rate determines how quickly the world stock of productive capital
can grow.
3. Trade imbalances. As we saw in earlier chapters, the value of a country’s
imports equals the value of its exports when spending equals income. This
state of balanced trade is seldom attained by actual economies, however. In
the following chapters, trade imbalances play a large role because they redistribute
wealth among countries and are a main channel through which one
country’s macroeconomic policies affect its trading partners. It should be no
surprise, therefore, that trade imbalances, particularly when they are large
and persistent, quickly can become a source of international discord.
4. Money and the price level. The trade theory you have studied so far is a
barter theory, one in which goods are exchanged directly for other goods on
the basis of their relative prices. In practice, it is more convenient to use
money—a widely acceptable medium of exchange—in transactions, and to
quote prices in terms of money. Because money changes hands in virtually
every transaction that takes place in a modern economy, fluctuations in the
supply of money or in the demand for it can affect both output and employment.
International macroeconomics takes into account that every country
uses a currency and that a monetary change (for example, a change in
money supply) in one country can have effects that spill across its borders to
other countries. Stability in money price levels is an important goal of international
macroeconomic policy.
This chapter takes the first step in our study of international macroeconomics by
explaining the accounting concepts economists use to describe a country’s level of
production and its international transactions. To get a complete picture of the
macroeconomic linkages among economies that engage in international trade, we
have to master two related and essential tools. The first of these tools, national
income accounting, records all the expenditures that contribute to a country’s
income and output. The second tool, balance of payments accounting, helps us
CHAPTER 13 National Income Accounting and the Balance of Payments 295
keep track of both changes in a country’s indebtedness to foreigners and the
fortunes of its export and import-competing industries. The balance of payments
accounts also show the connection between foreign transactions and national
money supplies.
LEARNING GOALS
After reading this chapter, you will 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.
• 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.
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