The Balance of Payments Accounts
In addition to national income accounts, government economists and statisticians also
keep balance of payments accounts, a detailed record of the composition of the current
account balance and of the many transactions that finance it.9 Balance of payments figures
are of great interest to the general public, as indicated by the attention that various news
media pay to them. But press reports sometimes confuse different measures of international
payments flows. Should we be alarmed or cheered by a Wall Street Journal headline
proclaiming, “U.S. Chalks Up Record Balance of Payments Deficit”? A thorough understanding
of balance of payments accounting will help us evaluate the implications of a
country’s international transactions.
A country’s balance of payments accounts keep track of both its payments to and 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. Three types of international transaction are recorded in the
balance of payments:
1. Transactions that arise from the export or import of goods or services and therefore
enter directly into the current account. When a French consumer imports American
blue jeans, for example, the transaction enters the U.S. balance of payments accounts
as a credit on 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 financial account of the balance of payments records all
international purchases or sales of financial assets. When an American company
buys a French factory, the transaction enters the U.S. balance of payments as a debit
in the financial account. It enters as a debit because the transaction requires a
9 The U.S. government is in the process of changing its balance of payments presentation to conform to prevailing
international standards, so our discussion in this chapter differs in some respects from that in prior editions of
this book. We follow the methodology described by Kristy L. Howell and Robert E. Yuskavage, “Modernizing
and Enhancing BEA’s International Economic Accounts: Recent Progress and Future Directions,” Survey of
Current Business (May 2010), pp. 6–20. As of this writing the U.S. has not completed a full transition to the new
system, but it is expected to do so over the early 2010s.
CHAPTER 13 National Income Accounting and the Balance of Payments 307
payment from the United States to foreigners. Correspondingly, a U.S. sale of assets
to foreigners enters the U.S. financial account as a credit. The difference between a
country’s purchases and sales of foreign assets is called its financial account balance,
or its net financial flows.
3. Certain other activities resulting in transfers of wealth between countries are recorded
in the capital account. These international asset movements—which are generally
very small for the United States—differ from those recorded in the financial account.
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). For example, if the U.S. government forgives $1 billion in debt
owed to it by the government of Pakistan, U.S. wealth declines by $1 billion and a
$1 billion debit is recorded in the U.S. capital account.
You will find the complexities of the balance of payments accounts less confusing if
you keep in mind the following simple rule of double-entry bookkeeping: Every international
transaction automatically enters the balance of payments twice, once as a
credit and once as a debit. This principle of balance of payments accounting holds true
because every transaction has two sides: If you buy something from a foreigner, you
must pay him in some way, and the foreigner must then somehow spend or store your
payment.
Examples of Paired Transactions
Some examples will show how the principle of double-entry bookkeeping operates in
practice.
1. Imagine you buy an ink-jet fax machine from the Italian company Olivetti and pay for
your purchase with a $1,000 check. Your payment to buy a good (the fax machine)
from a foreign resident enters the U.S. current account as a debit. But where is the offsetting
balance of payments credit? Olivetti’s U.S. salesperson must do something
with your check—let’s say he deposits it in Olivetti’s account at Citibank in New York.
In this case, Olivetti has purchased, and Citibank has sold, a U.S. asset—a bank
deposit worth $1,000—and the transaction shows up as a $1,000 credit in the U.S.
financial account. The transaction creates the following two offsetting bookkeeping
entries in the U.S. balance of payments:
Credit Debit
Fax machine purchase (Current account, U.S. good import) $1,000
Sale of bank deposit by Citibank
(Financial account, U.S. asset sale) $1,000
2. As another example, suppose that during your travels in France, you pay $200 for a
fine dinner at the Restaurant de l’Escargot d’Or. Lacking cash, you place the charge on
your Visa credit card. Your payment, which is a tourist expenditure, will be counted as
a service import for the United States, and therefore as a current account debit. Where
is the offsetting credit? Your signature on the Visa slip entitles the restaurant to receive
$200 (actually, its local currency equivalent) from First Card, the company that issued
your Visa card. It is therefore an asset, a claim on a future payment from First Card.
So when you pay for your meal abroad with your credit card, you are selling an asset
3. Imagine next that your Uncle Sid from Los Angeles buys a newly issued share of stock
in the U.K. oil giant British Petroleum (BP). He places his order with his stockbroker,
Go-for-Broke, Inc., paying $95 with a check drawn on his Go-for-Broke money market
account. BP, in turn, deposits the $95 Sid has paid into its own U.S. bank account
at Second Bank of Chicago. Uncle Sid’s acquisition of the stock creates a $95 debit in
the U.S. financial account (he has purchased an asset from a foreign resident, BP),
while BP’s $95 deposit at its Chicago bank is the offsetting financial account credit
(BP has expanded its U.S. asset holdings). The mirror-image effects on the U.S. balance
of payments therefore both appear in the financial account:
308 PART THREE Exchange Rates and Open-Economy Macroeconomics
4. Finally, let’s consider how the U.S. balance of payments accounts are affected when
U.S. banks forgive (that is, announce that they will simply forget about) $5,000 in debt
owed to them by the government of the imaginary country of Bygonia. In this case, the
United States makes a $5,000 capital transfer to Bygonia, which appears as a $5,000
debit entry in the capital account. The associated credit is in the financial account, in
the form of a $5,000 reduction in U.S. assets held abroad (a negative “acquisition” of
foreign assets, and therefore a balance of payments credit):
These examples show that many circumstances can affect the way a transaction
generates its offsetting balance of payments entry. We can never predict with certainty
where the flip side of a particular transaction will show up, but we can be sure that it
will show up somewhere.
The Fundamental Balance of Payments Identity
Because any international transaction automatically gives rise to offsetting credit and debit
entries in the balance of payments, the sum of the current account balance and the capital
account balance automatically equals the financial account balance:
Current account + capital account = Financial account. (13-3)
Credit Debit
Uncle Sid’s purchase of a share of BP
(Financial account, U.S. asset purchase)
$95
BP’s deposit of Uncle Sid’s payment at Second Bank of Chicago
(Financial account, U.S. asset sale)
$95
Credit Debit
U.S. banks’ debt forgiveness
(Capital account, U.S. transfer payment)
$5,000
Reduction in banks’ claims on Bygonia
(Financial account, U.S. asset sale)
$5,000
Credit Debit
Meal purchase (Current account, U.S. service import) $200
Sale of claim on First Card
(Financial account, U.S. asset sale) $200
to France and generating a $200 credit in the U.S. financial account. The pattern of
offsetting debits and credits in this case is:
CHAPTER 13 National Income Accounting and the Balance of Payments 309
In examples 1, 2, and 4 above, current or capital account entries have offsetting counterparts
in the financial account, while in example 3, two financial account entries offset each other.
You can understand this identity another way. Recall the relationship linking the current
account to international lending and borrowing. Because the sum of the current and
capital accounts is the total change in a country’s net foreign assets (including, through the
capital account, nonmarket asset transfers), that sum necessarily equals the difference
between a country’s purchases of assets from foreigners and its sales of assets to them—
that is, the financial account balance (also called net financial flows).
We now turn to a more detailed description of the balance of payments accounts, using
as an example the U.S. accounts for 2009.
The Current Account, Once Again
As you have learned, the current account balance measures a country’s net exports of
goods and services. Table 13-2 shows that U.S. exports (on the credit side) were $2,159.0
billion in 2009, while U.S. imports (on the debit side) were $2,412.5 billion.
TABLE 13-2 U.S. Balance of Payments Accounts for 2009 (billions of dollars)
Current Account
(1) Exports 2,159.0
Of which:
Goods 1,068.5
Services 502.3
Income receipts (primary income) 588.2
(2) Imports 2,412.5
Of which:
Goods 1,575.4
Services 370.3
Income payments (primary income) 466.8
(3) Net unilateral transfers (secondary income) -124.9
Balance on current account -378.4
[112 + 122 + 132]
Capital Account
(4) -0.1
Financial Account
(5) Net U.S. acquisition of financial assets, excluding financial derivatives 140.5
Of which:
Official reserve assets 52.3
Other assets 88.2
(6) Net U.S. incurrence of liabilities, excluding financial derivatives 305.7
Of which:
Official reserve assets 450.0
Other assets -144.3
(7) Financial derivatives, net -50.8
Net financial flows -216.0
[(5) - (6) + (7)]
Net errors and omissions 162.5
[Net financial flows less sum of current and capital accounts]
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 17, 2010, release. Totals may
differ from sums because of rounding.
310 PART THREE Exchange Rates and Open-Economy Macroeconomics
The balance of payments accounts divide exports and imports into three finer categories.
The first is goods trade, that is, exports or imports of merchandise. The second
category, services, includes items such as payments for legal assistance, tourists’ expenditures,
and shipping fees. The final category, income, is made up mostly of international
interest and dividend payments and the earnings of domestically owned firms operating
abroad. If you own a share of a German firm’s stock and receive a dividend payment of $5,
that payment shows up in the accounts as a U.S. investment income receipt of $5. Wages
that workers earn abroad can also enter the income account.
We include income on foreign investments in the current account because that income
really is compensation for the services provided by foreign investments. This idea, as we
saw earlier, is behind the distinction between GNP and GDP. When a U.S. corporation
builds a plant in Canada, for instance, the productive services the plant generates are
viewed as a service export from the United States to Canada equal in value to the profits
the plant yields for its American owner. To be consistent, we must be sure to include these
profits in American GNP and not in Canadian GNP. Remember, the definition of GNP
refers to goods and services generated by a country’s factors of production, but it does not
specify that those factors must work within the borders of the country that owns them.
Before calculating the current account, we must include one additional type of international
transaction that we have largely ignored until now. In discussing the relationship
between GNP and national income, we defined unilateral transfers between countries as
international gifts, that is, payments that do not correspond to the purchase of any good,
service, or asset. Net unilateral transfers are considered part of the current account as
well as a part of national income, and the identity holds exactly if
Y is interpreted as GNP plus net transfers. In 2009, the U.S. balance of unilateral transfers
was .
The table shows a 2009 current account balance of $2,159.0 billion
, a deficit. The negative sign means that current
payments to foreigners exceeded current receipts and that U.S. residents used
more output than they produced. Since these current account transactions were paid for
in some way, we know that this $378.4 billion net debit entry must be offset by a net
$378.4 billion credit elsewhere in the balance of payments.
The Capital Account
The capital account entry in Table 13-2 shows that in 2009, the United States paid out net
capital asset transfers of roughly $0.1 billion. These payments by the United States are a net
balance of payments debit. After we add them to the payments deficit implied by the current
account, we find that the United States’ need to cover its excess payments to foreigners
is raised very slightly, from $378.4 billion to $378.5 billion. Because an excess of national
spending over income must be covered by net borrowing from foreigners, this negative current
plus capital account balance must be matched by an equal negative balance of net
financial flows, representing the net liabilities the United States incurred to foreigners in
2009 in order to fund its deficit.
The Financial Account
While the current account is the difference between sales of goods and services to foreigners
and purchases of goods and services from them, the financial account measures the difference
between acquisitions of assets from foreigners and the buildup of liabilities to them.
When the United States borrows $1 from foreigners, it is selling them an asset—a promise
that they will be repaid $1, with interest, in the future. Likewise, when the United States
lends abroad, it acquires an asset: the right to claim future repayment from foreigners.
billion - $124.9 billion = -$378.4 billion
- $2,412.5
- $124.9 billion
Y = C + I + G + CA
CHAPTER 13 National Income Accounting and the Balance of Payments 311
To cover its 2009 current plus capital account deficit of $378.5 billion, the United
States needed to borrow from foreigners (or otherwise sell assets to them) in the net
amount of $378.5 billion. We can look again at Table 13-2 to see exactly how this net sale
of assets to foreigners came about.
The table records separately U.S. acquisitions of foreign financial assets (which are
balance of payments debits, because the United States must pay foreigners for those
assets) and increases in foreign claims on residents of the United States (which are balance
of payments credits, because the United States receives payments when it sells assets
overseas).
These data on increases in U.S. asset holdings abroad and foreign holdings of U.S.
assets do not include holdings of financial derivatives, which are a class of assets that are
more complicated than ordinary stocks and bonds, but have values that can depend on
stock and bond values. (We will describe some specific derivative securities in the next
chapter.) Starting in 2006, the U.S. Department of Commerce was able to assemble data
on net cross-border derivative flows for the United States (U.S. net purchases of foreignissued
derivatives less foreign net purchases of U.S.-issued derivatives). Derivatives transactions
enter the balance of payments accounts in the same way as do other international
asset transactions.
According to Table 13-2, U.S.-owned assets abroad (other than derivatives)
increased (on a net basis) by $140.5 billion in 2009. The figure is “on a net basis”
because some U.S. residents bought foreign assets while others sold foreign assets they
already owned, the difference between U.S. gross purchases and sales of foreign assets
being $140.5 billion. In the same year (again on a net basis), the United States incurred
new liabilities to foreigners equal to $305.7 billion. Some U.S. residents undoubtedly
repaid foreign debts, but new borrowing from foreigners exceeded these repayments
by $305.7 billion. The balance of U.S. sales and purchases of financial derivatives was
: The United States sold more derivative claims to foreigners than it
acquired. We calculate the balance on financial account (net financial flows) as
. The negative value for
net financial flows means that in 2009, the United States increased its net liability to
foreigners (liabilities minus assets) by $216.0 billion.
Net Errors and Omissions
We come out with net financial flows of rather than the
that we’d expected. According to our data on trade and financial flows, the United States
found less financing abroad than it needed to fund its current plus capital account deficit. If
every balance of payments credit automatically generates an equal counterpart debit and vice
versa, how is this difference possible? The reason is that information about the offsetting
debit and credit items associated with a given transaction may be collected from different
sources. For example, the import debit that a shipment of DVD players from Japan generates
may come from a U.S. customs inspector’s report and the corresponding financial account
credit from a report by the U.S. bank in which the check paying for the DVD players is
deposited. Because data from different sources may differ in coverage, accuracy, and timing,
the balance of payments accounts seldom balance in practice as they must in theory. Account
keepers force the two sides to balance by adding to the accounts a net errors and omissions
item. For 2009, unrecorded (or misrecorded) international transactions generated a balancing
accounting credit of $162.5 billion—the difference between the recorded net financial flows
and the sum of the recorded current and capital accounts.
We have no way of knowing exactly how to allocate this discrepancy among the current,
capital, and financial accounts. (If we did, it wouldn’t be a discrepancy!) The financial
- $216.0 billion - $378.5 billion
$140.5 billion - $305.7 billion- $50.8 billion = - $216.0 billion
- $50.8 billion
312 PART THREE Exchange Rates and Open-Economy Macroeconomics
account is the most likely culprit, since it is notoriously difficult to keep track of the complicated
financial trades between residents of different countries. But we cannot conclude that
net financial flows were $162.5 billion lower than recorded, because the current account is
also highly suspect. Balance of payments accountants consider merchandise trade data relatively
reliable, but data on services are not. Service transactions such as sales of financial
advice and computer programming assistance may escape detection. Accurate measurement
of international interest and dividend receipts is particularly difficult.
Official Reserve Transactions
Although there are many types of financial account transactions, one type is important
enough to merit separate discussion. This type of transaction is the purchase or sale of
official reserve assets by central banks.
An economy’s central bank is the institution responsible for managing the supply of
money. In the United States, the central bank is the Federal Reserve System. Official
international reserves are foreign assets held by central banks as a cushion against
national economic misfortune. At one time, official reserves consisted largely of gold, but
today, central banks’ reserves include substantial foreign financial assets, particularly U.S.
dollar assets such as Treasury bills. The Federal Reserve itself holds only a small level of
official reserve assets other than gold; its own holdings of U.S. dollar assets are not considered
international reserves.
Central banks often buy or sell international reserves in private asset markets to affect
macroeconomic conditions in their economies. Official transactions of this type are called
official foreign exchange intervention. One reason why foreign exchange intervention
can alter macroeconomic conditions is that it is a way for the central bank to inject money
into the economy or withdraw it from circulation. We will have much more to say later
about the causes and consequences of foreign exchange intervention.
Government agencies other than central banks may hold foreign reserves and intervene
officially in exchange markets. The U.S. Treasury, for example, operates an Exchange
Stabilization Fund that at times has played an active role in market trading. Because the
operations of such agencies usually have no noticeable impact on the money supply, however,
we will simplify our discussion by speaking (when it is not too misleading) as if the
central bank alone holds foreign reserves and intervenes.
When a central bank purchases or sells a foreign asset, the transaction appears in its
country’s financial account just as if the same transaction had been carried out by a private
citizen. A transaction in which the central bank of Japan (the Bank of Japan) acquires dollar
assets might occur as follows: A U.S. auto dealer imports a Nissan sedan from Japan and
pays the auto company with a check for $20,000. Nissan does not want to invest the money
in dollar assets, but it so happens that the Bank of Japan is willing to give Nissan Japanese
money in exchange for the $20,000 check. The Bank of Japan’s international reserves rise
by $20,000 as a result of the deal. Because the Bank of Japan’s dollar reserves are part of
total Japanese assets held in the United States, the latter rise by $20,000. This transaction
therefore results in a $20,000 credit in the U.S. financial account, the other side of the
$20,000 debit in the U.S. current account due to the import of the car.10
Table 13-2 shows the size and direction of official reserve transactions involving the
United States in 2009. U.S. official reserve assets—that is, international reserves held by
the Federal Reserve—rose by $52.3 billion. Foreign central banks purchased $450.0 billion
to add to their reserves. The net increase in U.S. official reserves less the increase in foreign
10To test your understanding, see if you can explain why the same sequence of actions causes a $20,000
improvement in Japan’s current account and a $20,000 increase in its net financial flows.
CHAPTER 13 National Income Accounting and the Balance of Payments 313
official reserve claims on the United States is the level of net central bank financial flows,
which stood at in 2009.
You can think of this net central bank financial flow as measuring the
degree to which monetary authorities in the United States and abroad joined with other
lenders to cover the U.S. current account deficit. In the example above, the Bank of Japan,
by acquiring a $20,000 U.S. bank deposit, indirectly finances an American import of a
$20,000 Japanese car. The level of net central bank financial flows is called the official
settlements balance or (in less formal usage) the balance of payments. This balance is
the sum of the current account and capital account balances, less the nonreserve portion of
the financial account balance, and it indicates the payments gap that official reserve transactions
need to cover. Thus the U.S. balance of payments in 2009 was .
The balance of payments played an important historical role as a measure of disequilibrium
in international payments, and for many countries it still plays this role. A negative
balance of payments (a deficit) may signal a crisis, for it means that a country is running
down its international reserve assets or incurring debts to foreign monetary authorities. If a
country faces the risk of being suddenly cut off from foreign loans, it will want to maintain
a “war chest” of international reserves as a precaution. Developing countries, in particular,
are in this position (see Chapter 22).
Like any summary measure, however, the balance of payments must be interpreted with
caution. To return to our running example, the Bank of Japan’s decision to expand its U.S.
bank deposit holdings by $20,000 swells the measured U.S. balance of payments deficit by
the same amount. Suppose the Bank of Japan instead places its $20,000 with Barclays
Bank in London, which in turn deposits the money with Citibank in New York. The United
States incurs an extra $20,000 in liabilities to private foreigners in this case, and the U.S.
balance of payments deficit does not rise. But this “improvement” in the balance of payments
is of little economic importance: It makes no real difference to the United States
whether it borrows the Bank of Japan’s money directly or through a London bank.
Case Study
The Assets and Liabilities of the World’s Biggest Debtor
We saw earlier that the current account balance measures the flow of new net claims on
foreign wealth that a country acquires by exporting more goods and services than it imports.
This flow is not, however, the only important factor that causes a country’s net
foreign wealth to change. In addition, changes in the market price of wealth previously
acquired can alter a country’s net foreign wealth. When Japan’s stock market lost threequarters
of its value over the 1990s, for example, American and European owners of
Japanese shares saw the value of their claims on Japan plummet, and Japan’s net
foreign wealth increased as a result. Exchange rate changes have a similar effect. When
the dollar depreciates against foreign currencies, for example, foreigners who hold dollar
assets see their wealth fall when measured in their home currencies.
The Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce,
which oversees the vast job of data collection behind the U.S. national income and balance
of payments statistics, reports annual estimates of the net “international investment
position” of the United States—the country’s foreign assets less its foreign liabilities.
Because asset price and exchange rate changes alter the dollar values of foreign assets
and liabilities alike, the BEA must adjust the values of existing claims to reflect such
capital gains and losses in order to estimate U.S. net foreign wealth. These estimates
- $397.7 billion
- $397.7 billion
$52.3 - $450.0 billion = -$397.7 billion
TABLE 13-3 International Investment Position of the United States at Year End,
2008 and 2009 (millions of dollars)
Source: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, July 2010.
314 PART THREE Exchange Rates and Open-Economy Macroeconomics
show that at the end of 2009, the United States had a negative net foreign wealth position
far greater than that of any other country.
Until 1991, foreign direct investments such as foreign factories owned by U.S. corporations
were valued at their historical, that is, original, purchase prices. Now the BEA uses
two different methods to place current values on foreign direct investments: the current cost
method, which values direct investments at the cost of buying them today, and the market
value method, which is meant to measure the price at which the investments could be sold.
These methods can lead to different valuations because the cost of replacing a particular
direct investment and the price it would command if sold on the market may be hard to
measure. (The net foreign wealth data graphed in Figure 13-2 are current cost estimates.)
Table 13-3 reproduces the BEA’s account of how it made its valuation adjustments
to find the U.S. net foreign position at the end of 2009. This “headline” estimate values
CHAPTER 13 National Income Accounting and the Balance of Payments 315
direct investments at current cost. Starting with its estimate of 2008 net foreign wealth
( at current cost), the BEA (column a) added the amount of the 2009
U.S. net financial flow of —recall the figure reported in Table 13-2.
Then the BEA adjusted the values of previously held assets and liabilities for various
changes in their dollar prices (columns b, c, and d). As a result of these valuation
changes, U.S. net foreign wealth fell by an amount much smaller than the $216 billion
in new net borrowing from foreigners—in fact, U.S. net foreign wealth actually rose, as
shown in Figure 13-2! Based on the current cost method for valuing direct investments,
the BEA’s 2009 estimate of U.S. net foreign wealth was .
This debt is larger than the total foreign debt owed by all the Central and Eastern
European countries, which was about $1,100 billion in 2009. To put these figures in perspective,
however, it is important to realize that the U.S. net foreign debt amounted to just
under 20 percent of its GDP, while the foreign liability of Hungary, Poland, Romania, and
the other Central and Eastern European debtors was nearly 70 percent of their collective
GDP! Thus, the U.S. external debt represents a much lower domestic income drain.
Changes in exchange rates and securities prices have the potential to change the U.S.
net foreign debt sharply, however, because the gross foreign assets and liabilities of the
United States have become so large in recent years. Figure 13-3 illustrates this dramatic
trend. In 1976, U.S. foreign assets stood at only 25 percent of U.S. GDP and liabilities
at 16 percent (making the United States a net foreign creditor in the amount of roughly
9 percent of its GDP). In 2009, however, the country’s foreign assets amounted to 129
percent of GDP and its liabilities to 148 percent. The tremendous growth in these
- $2,737.8 billion
- $216 billion
- $3,493.9 billion
0
0.2
0.4
0.6
0.8
1
1.2
1.6
1.4
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Assets, liabilities
(ratio to GDP)
2006 2008
Gross foreign liabilities
Gross foreign assets
Figure 13-3
U.S. Gross Foreign Assets and Liabilities, 1976–2009
Since 1976, both the foreign assets and the liabilities of the United States have increased sharply. But liabilities
have risen more quickly, leaving the United States with a substantial net foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2010.
316 PART THREE Exchange Rates and Open-Economy Macroeconomics
stocks of wealth reflects the rapid globalization of financial markets in the late 20th
century, a phenomenon we will discuss further in Chapter 21.
Think about how wealth positions of this magnitude amplify the effects of exchange
rate changes, however. Suppose that 70 percent of U.S. foreign assets are denominated in
foreign currencies, but that all U.S. liabilities to foreigners are denominated in dollars
(these are approximately the correct numbers). Because 2009 U.S. GDP was around $14.4
trillion, a 10 percent depreciation of the dollar would leave U.S. liabilities unchanged but
would increase U.S. assets (measured in dollars) by percent of
GDP, or about $1.3 trillion. This number is approximately 3.5 times the U.S. current
account deficit of 2009! Indeed, due to sharp movements in exchange rates and stock
prices, the U.S. economy lost about $800 billion in this way between 2007 and 2008 and
gained a comparable amount between 2008 and 2009 (see Figure 13-2). The corresponding
redistribution of wealth between foreigners and the United States would have been
much smaller back in 1976.
Does this possibility mean that policy makers should ignore their countries’ current
accounts and instead try to manipulate currency values to prevent large buildups of net
foreign debt? That would be a perilous strategy because, as we will see in the next chapter,
expectations of future exchange rates are central to market participants’ behavior.
Systematic government attempts to reduce foreign investors’ wealth through exchange
rate changes would sharply reduce foreigners’ demand for domestic currency assets, thus
decreasing or eliminating any wealth benefit from depreciating the home currency.
0.1 * 0.7 * 1.29 = 9.0
SUMMARY
1. International macroeconomics is concerned with the full employment of scarce economic
resources and price level stability throughout the world economy. Because they
reflect national expenditure patterns and their international repercussions, the national
income accounts and the balance of payments accounts are essential tools for studying
the macroeconomics of open, interdependent economies.
2. A country’s gross national product (GNP) is equal to the income received by its factors of
production. The national income accounts divide national income according to the types of
spending that generate it: consumption, investment, government purchases, and the current
account balance. Gross domestic product (GDP), equal to GNP less net receipts of factor
income from abroad, measures the output produced within a country’s territorial borders.
3. In an economy closed to international trade, GNP must be consumed, invested, or purchased
by the government. By using current output to build plant, equipment, and
inventories, investment transforms present output into future output. For a closed
economy, investment is the only way to save in the aggregate, so the sum of the saving
carried out by the private and public sectors, national saving, must equal investment.
4. In an open economy, GNP equals the sum of consumption, investment, government
purchases, and net exports of goods and services. Trade does not have to be balanced if
the economy can borrow from and lend to the rest of the world. The difference
between the economy’s exports and imports, the current account balance, equals the
difference between the economy’s output and its total use of goods and services.
5. The current account also equals the country’s net lending to foreigners. Unlike a closed
economy, an open economy can save by domestic and foreign investments. National
saving therefore equals domestic investment plus the current account balance.
6. Balance of payments accounts provide a detailed picture of the composition and financing
of the current account. All transactions between a country and the rest of the world are
recorded in the country’s balance of payments accounts. The accounts are based on the
convention that any transaction resulting in a payment to foreigners is entered as a debit
while any transaction resulting in a receipt from foreigners is entered as a credit.
7. Transactions involving goods and services appear in the current account of the balance of
payments, while international sales or purchases of assets appear in the financial
account. The capital account records mainly nonmarket asset transfers and tends to be
small for the United States. The sum of the current and capital account balances must
equal the financial account balance (net financial flows). This feature of the accounts
reflects the fact that discrepancies between export earnings and import expenditures must
be matched by a promise to repay the difference, usually with interest, in the future.
8. International asset transactions carried out by central banks are included in the financial
account. Any central bank transaction in private markets for foreign currency assets is
called official foreign exchange intervention. One reason intervention is important is that
central banks use it as a way to change the amount of money in circulation. A country has
a deficit in its balance of payments when it is running down its official international
reserves or borrowing from foreign central banks; it has a surplus in the opposite case.
In addition to national income accounts, government economists and statisticians also
keep balance of payments accounts, a detailed record of the composition of the current
account balance and of the many transactions that finance it.9 Balance of payments figures
are of great interest to the general public, as indicated by the attention that various news
media pay to them. But press reports sometimes confuse different measures of international
payments flows. Should we be alarmed or cheered by a Wall Street Journal headline
proclaiming, “U.S. Chalks Up Record Balance of Payments Deficit”? A thorough understanding
of balance of payments accounting will help us evaluate the implications of a
country’s international transactions.
A country’s balance of payments accounts keep track of both its payments to and 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. Three types of international transaction are recorded in the
balance of payments:
1. Transactions that arise from the export or import of goods or services and therefore
enter directly into the current account. When a French consumer imports American
blue jeans, for example, the transaction enters the U.S. balance of payments accounts
as a credit on 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 financial account of the balance of payments records all
international purchases or sales of financial assets. When an American company
buys a French factory, the transaction enters the U.S. balance of payments as a debit
in the financial account. It enters as a debit because the transaction requires a
9 The U.S. government is in the process of changing its balance of payments presentation to conform to prevailing
international standards, so our discussion in this chapter differs in some respects from that in prior editions of
this book. We follow the methodology described by Kristy L. Howell and Robert E. Yuskavage, “Modernizing
and Enhancing BEA’s International Economic Accounts: Recent Progress and Future Directions,” Survey of
Current Business (May 2010), pp. 6–20. As of this writing the U.S. has not completed a full transition to the new
system, but it is expected to do so over the early 2010s.
CHAPTER 13 National Income Accounting and the Balance of Payments 307
payment from the United States to foreigners. Correspondingly, a U.S. sale of assets
to foreigners enters the U.S. financial account as a credit. The difference between a
country’s purchases and sales of foreign assets is called its financial account balance,
or its net financial flows.
3. Certain other activities resulting in transfers of wealth between countries are recorded
in the capital account. These international asset movements—which are generally
very small for the United States—differ from those recorded in the financial account.
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). For example, if the U.S. government forgives $1 billion in debt
owed to it by the government of Pakistan, U.S. wealth declines by $1 billion and a
$1 billion debit is recorded in the U.S. capital account.
You will find the complexities of the balance of payments accounts less confusing if
you keep in mind the following simple rule of double-entry bookkeeping: Every international
transaction automatically enters the balance of payments twice, once as a
credit and once as a debit. This principle of balance of payments accounting holds true
because every transaction has two sides: If you buy something from a foreigner, you
must pay him in some way, and the foreigner must then somehow spend or store your
payment.
Examples of Paired Transactions
Some examples will show how the principle of double-entry bookkeeping operates in
practice.
1. Imagine you buy an ink-jet fax machine from the Italian company Olivetti and pay for
your purchase with a $1,000 check. Your payment to buy a good (the fax machine)
from a foreign resident enters the U.S. current account as a debit. But where is the offsetting
balance of payments credit? Olivetti’s U.S. salesperson must do something
with your check—let’s say he deposits it in Olivetti’s account at Citibank in New York.
In this case, Olivetti has purchased, and Citibank has sold, a U.S. asset—a bank
deposit worth $1,000—and the transaction shows up as a $1,000 credit in the U.S.
financial account. The transaction creates the following two offsetting bookkeeping
entries in the U.S. balance of payments:
Credit Debit
Fax machine purchase (Current account, U.S. good import) $1,000
Sale of bank deposit by Citibank
(Financial account, U.S. asset sale) $1,000
2. As another example, suppose that during your travels in France, you pay $200 for a
fine dinner at the Restaurant de l’Escargot d’Or. Lacking cash, you place the charge on
your Visa credit card. Your payment, which is a tourist expenditure, will be counted as
a service import for the United States, and therefore as a current account debit. Where
is the offsetting credit? Your signature on the Visa slip entitles the restaurant to receive
$200 (actually, its local currency equivalent) from First Card, the company that issued
your Visa card. It is therefore an asset, a claim on a future payment from First Card.
So when you pay for your meal abroad with your credit card, you are selling an asset
3. Imagine next that your Uncle Sid from Los Angeles buys a newly issued share of stock
in the U.K. oil giant British Petroleum (BP). He places his order with his stockbroker,
Go-for-Broke, Inc., paying $95 with a check drawn on his Go-for-Broke money market
account. BP, in turn, deposits the $95 Sid has paid into its own U.S. bank account
at Second Bank of Chicago. Uncle Sid’s acquisition of the stock creates a $95 debit in
the U.S. financial account (he has purchased an asset from a foreign resident, BP),
while BP’s $95 deposit at its Chicago bank is the offsetting financial account credit
(BP has expanded its U.S. asset holdings). The mirror-image effects on the U.S. balance
of payments therefore both appear in the financial account:
308 PART THREE Exchange Rates and Open-Economy Macroeconomics
4. Finally, let’s consider how the U.S. balance of payments accounts are affected when
U.S. banks forgive (that is, announce that they will simply forget about) $5,000 in debt
owed to them by the government of the imaginary country of Bygonia. In this case, the
United States makes a $5,000 capital transfer to Bygonia, which appears as a $5,000
debit entry in the capital account. The associated credit is in the financial account, in
the form of a $5,000 reduction in U.S. assets held abroad (a negative “acquisition” of
foreign assets, and therefore a balance of payments credit):
These examples show that many circumstances can affect the way a transaction
generates its offsetting balance of payments entry. We can never predict with certainty
where the flip side of a particular transaction will show up, but we can be sure that it
will show up somewhere.
The Fundamental Balance of Payments Identity
Because any international transaction automatically gives rise to offsetting credit and debit
entries in the balance of payments, the sum of the current account balance and the capital
account balance automatically equals the financial account balance:
Current account + capital account = Financial account. (13-3)
Credit Debit
Uncle Sid’s purchase of a share of BP
(Financial account, U.S. asset purchase)
$95
BP’s deposit of Uncle Sid’s payment at Second Bank of Chicago
(Financial account, U.S. asset sale)
$95
Credit Debit
U.S. banks’ debt forgiveness
(Capital account, U.S. transfer payment)
$5,000
Reduction in banks’ claims on Bygonia
(Financial account, U.S. asset sale)
$5,000
Credit Debit
Meal purchase (Current account, U.S. service import) $200
Sale of claim on First Card
(Financial account, U.S. asset sale) $200
to France and generating a $200 credit in the U.S. financial account. The pattern of
offsetting debits and credits in this case is:
CHAPTER 13 National Income Accounting and the Balance of Payments 309
In examples 1, 2, and 4 above, current or capital account entries have offsetting counterparts
in the financial account, while in example 3, two financial account entries offset each other.
You can understand this identity another way. Recall the relationship linking the current
account to international lending and borrowing. Because the sum of the current and
capital accounts is the total change in a country’s net foreign assets (including, through the
capital account, nonmarket asset transfers), that sum necessarily equals the difference
between a country’s purchases of assets from foreigners and its sales of assets to them—
that is, the financial account balance (also called net financial flows).
We now turn to a more detailed description of the balance of payments accounts, using
as an example the U.S. accounts for 2009.
The Current Account, Once Again
As you have learned, the current account balance measures a country’s net exports of
goods and services. Table 13-2 shows that U.S. exports (on the credit side) were $2,159.0
billion in 2009, while U.S. imports (on the debit side) were $2,412.5 billion.
TABLE 13-2 U.S. Balance of Payments Accounts for 2009 (billions of dollars)
Current Account
(1) Exports 2,159.0
Of which:
Goods 1,068.5
Services 502.3
Income receipts (primary income) 588.2
(2) Imports 2,412.5
Of which:
Goods 1,575.4
Services 370.3
Income payments (primary income) 466.8
(3) Net unilateral transfers (secondary income) -124.9
Balance on current account -378.4
[112 + 122 + 132]
Capital Account
(4) -0.1
Financial Account
(5) Net U.S. acquisition of financial assets, excluding financial derivatives 140.5
Of which:
Official reserve assets 52.3
Other assets 88.2
(6) Net U.S. incurrence of liabilities, excluding financial derivatives 305.7
Of which:
Official reserve assets 450.0
Other assets -144.3
(7) Financial derivatives, net -50.8
Net financial flows -216.0
[(5) - (6) + (7)]
Net errors and omissions 162.5
[Net financial flows less sum of current and capital accounts]
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 17, 2010, release. Totals may
differ from sums because of rounding.
310 PART THREE Exchange Rates and Open-Economy Macroeconomics
The balance of payments accounts divide exports and imports into three finer categories.
The first is goods trade, that is, exports or imports of merchandise. The second
category, services, includes items such as payments for legal assistance, tourists’ expenditures,
and shipping fees. The final category, income, is made up mostly of international
interest and dividend payments and the earnings of domestically owned firms operating
abroad. If you own a share of a German firm’s stock and receive a dividend payment of $5,
that payment shows up in the accounts as a U.S. investment income receipt of $5. Wages
that workers earn abroad can also enter the income account.
We include income on foreign investments in the current account because that income
really is compensation for the services provided by foreign investments. This idea, as we
saw earlier, is behind the distinction between GNP and GDP. When a U.S. corporation
builds a plant in Canada, for instance, the productive services the plant generates are
viewed as a service export from the United States to Canada equal in value to the profits
the plant yields for its American owner. To be consistent, we must be sure to include these
profits in American GNP and not in Canadian GNP. Remember, the definition of GNP
refers to goods and services generated by a country’s factors of production, but it does not
specify that those factors must work within the borders of the country that owns them.
Before calculating the current account, we must include one additional type of international
transaction that we have largely ignored until now. In discussing the relationship
between GNP and national income, we defined unilateral transfers between countries as
international gifts, that is, payments that do not correspond to the purchase of any good,
service, or asset. Net unilateral transfers are considered part of the current account as
well as a part of national income, and the identity holds exactly if
Y is interpreted as GNP plus net transfers. In 2009, the U.S. balance of unilateral transfers
was .
The table shows a 2009 current account balance of $2,159.0 billion
, a deficit. The negative sign means that current
payments to foreigners exceeded current receipts and that U.S. residents used
more output than they produced. Since these current account transactions were paid for
in some way, we know that this $378.4 billion net debit entry must be offset by a net
$378.4 billion credit elsewhere in the balance of payments.
The Capital Account
The capital account entry in Table 13-2 shows that in 2009, the United States paid out net
capital asset transfers of roughly $0.1 billion. These payments by the United States are a net
balance of payments debit. After we add them to the payments deficit implied by the current
account, we find that the United States’ need to cover its excess payments to foreigners
is raised very slightly, from $378.4 billion to $378.5 billion. Because an excess of national
spending over income must be covered by net borrowing from foreigners, this negative current
plus capital account balance must be matched by an equal negative balance of net
financial flows, representing the net liabilities the United States incurred to foreigners in
2009 in order to fund its deficit.
The Financial Account
While the current account is the difference between sales of goods and services to foreigners
and purchases of goods and services from them, the financial account measures the difference
between acquisitions of assets from foreigners and the buildup of liabilities to them.
When the United States borrows $1 from foreigners, it is selling them an asset—a promise
that they will be repaid $1, with interest, in the future. Likewise, when the United States
lends abroad, it acquires an asset: the right to claim future repayment from foreigners.
billion - $124.9 billion = -$378.4 billion
- $2,412.5
- $124.9 billion
Y = C + I + G + CA
CHAPTER 13 National Income Accounting and the Balance of Payments 311
To cover its 2009 current plus capital account deficit of $378.5 billion, the United
States needed to borrow from foreigners (or otherwise sell assets to them) in the net
amount of $378.5 billion. We can look again at Table 13-2 to see exactly how this net sale
of assets to foreigners came about.
The table records separately U.S. acquisitions of foreign financial assets (which are
balance of payments debits, because the United States must pay foreigners for those
assets) and increases in foreign claims on residents of the United States (which are balance
of payments credits, because the United States receives payments when it sells assets
overseas).
These data on increases in U.S. asset holdings abroad and foreign holdings of U.S.
assets do not include holdings of financial derivatives, which are a class of assets that are
more complicated than ordinary stocks and bonds, but have values that can depend on
stock and bond values. (We will describe some specific derivative securities in the next
chapter.) Starting in 2006, the U.S. Department of Commerce was able to assemble data
on net cross-border derivative flows for the United States (U.S. net purchases of foreignissued
derivatives less foreign net purchases of U.S.-issued derivatives). Derivatives transactions
enter the balance of payments accounts in the same way as do other international
asset transactions.
According to Table 13-2, U.S.-owned assets abroad (other than derivatives)
increased (on a net basis) by $140.5 billion in 2009. The figure is “on a net basis”
because some U.S. residents bought foreign assets while others sold foreign assets they
already owned, the difference between U.S. gross purchases and sales of foreign assets
being $140.5 billion. In the same year (again on a net basis), the United States incurred
new liabilities to foreigners equal to $305.7 billion. Some U.S. residents undoubtedly
repaid foreign debts, but new borrowing from foreigners exceeded these repayments
by $305.7 billion. The balance of U.S. sales and purchases of financial derivatives was
: The United States sold more derivative claims to foreigners than it
acquired. We calculate the balance on financial account (net financial flows) as
. The negative value for
net financial flows means that in 2009, the United States increased its net liability to
foreigners (liabilities minus assets) by $216.0 billion.
Net Errors and Omissions
We come out with net financial flows of rather than the
that we’d expected. According to our data on trade and financial flows, the United States
found less financing abroad than it needed to fund its current plus capital account deficit. If
every balance of payments credit automatically generates an equal counterpart debit and vice
versa, how is this difference possible? The reason is that information about the offsetting
debit and credit items associated with a given transaction may be collected from different
sources. For example, the import debit that a shipment of DVD players from Japan generates
may come from a U.S. customs inspector’s report and the corresponding financial account
credit from a report by the U.S. bank in which the check paying for the DVD players is
deposited. Because data from different sources may differ in coverage, accuracy, and timing,
the balance of payments accounts seldom balance in practice as they must in theory. Account
keepers force the two sides to balance by adding to the accounts a net errors and omissions
item. For 2009, unrecorded (or misrecorded) international transactions generated a balancing
accounting credit of $162.5 billion—the difference between the recorded net financial flows
and the sum of the recorded current and capital accounts.
We have no way of knowing exactly how to allocate this discrepancy among the current,
capital, and financial accounts. (If we did, it wouldn’t be a discrepancy!) The financial
- $216.0 billion - $378.5 billion
$140.5 billion - $305.7 billion- $50.8 billion = - $216.0 billion
- $50.8 billion
312 PART THREE Exchange Rates and Open-Economy Macroeconomics
account is the most likely culprit, since it is notoriously difficult to keep track of the complicated
financial trades between residents of different countries. But we cannot conclude that
net financial flows were $162.5 billion lower than recorded, because the current account is
also highly suspect. Balance of payments accountants consider merchandise trade data relatively
reliable, but data on services are not. Service transactions such as sales of financial
advice and computer programming assistance may escape detection. Accurate measurement
of international interest and dividend receipts is particularly difficult.
Official Reserve Transactions
Although there are many types of financial account transactions, one type is important
enough to merit separate discussion. This type of transaction is the purchase or sale of
official reserve assets by central banks.
An economy’s central bank is the institution responsible for managing the supply of
money. In the United States, the central bank is the Federal Reserve System. Official
international reserves are foreign assets held by central banks as a cushion against
national economic misfortune. At one time, official reserves consisted largely of gold, but
today, central banks’ reserves include substantial foreign financial assets, particularly U.S.
dollar assets such as Treasury bills. The Federal Reserve itself holds only a small level of
official reserve assets other than gold; its own holdings of U.S. dollar assets are not considered
international reserves.
Central banks often buy or sell international reserves in private asset markets to affect
macroeconomic conditions in their economies. Official transactions of this type are called
official foreign exchange intervention. One reason why foreign exchange intervention
can alter macroeconomic conditions is that it is a way for the central bank to inject money
into the economy or withdraw it from circulation. We will have much more to say later
about the causes and consequences of foreign exchange intervention.
Government agencies other than central banks may hold foreign reserves and intervene
officially in exchange markets. The U.S. Treasury, for example, operates an Exchange
Stabilization Fund that at times has played an active role in market trading. Because the
operations of such agencies usually have no noticeable impact on the money supply, however,
we will simplify our discussion by speaking (when it is not too misleading) as if the
central bank alone holds foreign reserves and intervenes.
When a central bank purchases or sells a foreign asset, the transaction appears in its
country’s financial account just as if the same transaction had been carried out by a private
citizen. A transaction in which the central bank of Japan (the Bank of Japan) acquires dollar
assets might occur as follows: A U.S. auto dealer imports a Nissan sedan from Japan and
pays the auto company with a check for $20,000. Nissan does not want to invest the money
in dollar assets, but it so happens that the Bank of Japan is willing to give Nissan Japanese
money in exchange for the $20,000 check. The Bank of Japan’s international reserves rise
by $20,000 as a result of the deal. Because the Bank of Japan’s dollar reserves are part of
total Japanese assets held in the United States, the latter rise by $20,000. This transaction
therefore results in a $20,000 credit in the U.S. financial account, the other side of the
$20,000 debit in the U.S. current account due to the import of the car.10
Table 13-2 shows the size and direction of official reserve transactions involving the
United States in 2009. U.S. official reserve assets—that is, international reserves held by
the Federal Reserve—rose by $52.3 billion. Foreign central banks purchased $450.0 billion
to add to their reserves. The net increase in U.S. official reserves less the increase in foreign
10To test your understanding, see if you can explain why the same sequence of actions causes a $20,000
improvement in Japan’s current account and a $20,000 increase in its net financial flows.
CHAPTER 13 National Income Accounting and the Balance of Payments 313
official reserve claims on the United States is the level of net central bank financial flows,
which stood at in 2009.
You can think of this net central bank financial flow as measuring the
degree to which monetary authorities in the United States and abroad joined with other
lenders to cover the U.S. current account deficit. In the example above, the Bank of Japan,
by acquiring a $20,000 U.S. bank deposit, indirectly finances an American import of a
$20,000 Japanese car. The level of net central bank financial flows is called the official
settlements balance or (in less formal usage) the balance of payments. This balance is
the sum of the current account and capital account balances, less the nonreserve portion of
the financial account balance, and it indicates the payments gap that official reserve transactions
need to cover. Thus the U.S. balance of payments in 2009 was .
The balance of payments played an important historical role as a measure of disequilibrium
in international payments, and for many countries it still plays this role. A negative
balance of payments (a deficit) may signal a crisis, for it means that a country is running
down its international reserve assets or incurring debts to foreign monetary authorities. If a
country faces the risk of being suddenly cut off from foreign loans, it will want to maintain
a “war chest” of international reserves as a precaution. Developing countries, in particular,
are in this position (see Chapter 22).
Like any summary measure, however, the balance of payments must be interpreted with
caution. To return to our running example, the Bank of Japan’s decision to expand its U.S.
bank deposit holdings by $20,000 swells the measured U.S. balance of payments deficit by
the same amount. Suppose the Bank of Japan instead places its $20,000 with Barclays
Bank in London, which in turn deposits the money with Citibank in New York. The United
States incurs an extra $20,000 in liabilities to private foreigners in this case, and the U.S.
balance of payments deficit does not rise. But this “improvement” in the balance of payments
is of little economic importance: It makes no real difference to the United States
whether it borrows the Bank of Japan’s money directly or through a London bank.
Case Study
The Assets and Liabilities of the World’s Biggest Debtor
We saw earlier that the current account balance measures the flow of new net claims on
foreign wealth that a country acquires by exporting more goods and services than it imports.
This flow is not, however, the only important factor that causes a country’s net
foreign wealth to change. In addition, changes in the market price of wealth previously
acquired can alter a country’s net foreign wealth. When Japan’s stock market lost threequarters
of its value over the 1990s, for example, American and European owners of
Japanese shares saw the value of their claims on Japan plummet, and Japan’s net
foreign wealth increased as a result. Exchange rate changes have a similar effect. When
the dollar depreciates against foreign currencies, for example, foreigners who hold dollar
assets see their wealth fall when measured in their home currencies.
The Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce,
which oversees the vast job of data collection behind the U.S. national income and balance
of payments statistics, reports annual estimates of the net “international investment
position” of the United States—the country’s foreign assets less its foreign liabilities.
Because asset price and exchange rate changes alter the dollar values of foreign assets
and liabilities alike, the BEA must adjust the values of existing claims to reflect such
capital gains and losses in order to estimate U.S. net foreign wealth. These estimates
- $397.7 billion
- $397.7 billion
$52.3 - $450.0 billion = -$397.7 billion
TABLE 13-3 International Investment Position of the United States at Year End,
2008 and 2009 (millions of dollars)
Source: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, July 2010.
314 PART THREE Exchange Rates and Open-Economy Macroeconomics
show that at the end of 2009, the United States had a negative net foreign wealth position
far greater than that of any other country.
Until 1991, foreign direct investments such as foreign factories owned by U.S. corporations
were valued at their historical, that is, original, purchase prices. Now the BEA uses
two different methods to place current values on foreign direct investments: the current cost
method, which values direct investments at the cost of buying them today, and the market
value method, which is meant to measure the price at which the investments could be sold.
These methods can lead to different valuations because the cost of replacing a particular
direct investment and the price it would command if sold on the market may be hard to
measure. (The net foreign wealth data graphed in Figure 13-2 are current cost estimates.)
Table 13-3 reproduces the BEA’s account of how it made its valuation adjustments
to find the U.S. net foreign position at the end of 2009. This “headline” estimate values
CHAPTER 13 National Income Accounting and the Balance of Payments 315
direct investments at current cost. Starting with its estimate of 2008 net foreign wealth
( at current cost), the BEA (column a) added the amount of the 2009
U.S. net financial flow of —recall the figure reported in Table 13-2.
Then the BEA adjusted the values of previously held assets and liabilities for various
changes in their dollar prices (columns b, c, and d). As a result of these valuation
changes, U.S. net foreign wealth fell by an amount much smaller than the $216 billion
in new net borrowing from foreigners—in fact, U.S. net foreign wealth actually rose, as
shown in Figure 13-2! Based on the current cost method for valuing direct investments,
the BEA’s 2009 estimate of U.S. net foreign wealth was .
This debt is larger than the total foreign debt owed by all the Central and Eastern
European countries, which was about $1,100 billion in 2009. To put these figures in perspective,
however, it is important to realize that the U.S. net foreign debt amounted to just
under 20 percent of its GDP, while the foreign liability of Hungary, Poland, Romania, and
the other Central and Eastern European debtors was nearly 70 percent of their collective
GDP! Thus, the U.S. external debt represents a much lower domestic income drain.
Changes in exchange rates and securities prices have the potential to change the U.S.
net foreign debt sharply, however, because the gross foreign assets and liabilities of the
United States have become so large in recent years. Figure 13-3 illustrates this dramatic
trend. In 1976, U.S. foreign assets stood at only 25 percent of U.S. GDP and liabilities
at 16 percent (making the United States a net foreign creditor in the amount of roughly
9 percent of its GDP). In 2009, however, the country’s foreign assets amounted to 129
percent of GDP and its liabilities to 148 percent. The tremendous growth in these
- $2,737.8 billion
- $216 billion
- $3,493.9 billion
0
0.2
0.4
0.6
0.8
1
1.2
1.6
1.4
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Assets, liabilities
(ratio to GDP)
2006 2008
Gross foreign liabilities
Gross foreign assets
Figure 13-3
U.S. Gross Foreign Assets and Liabilities, 1976–2009
Since 1976, both the foreign assets and the liabilities of the United States have increased sharply. But liabilities
have risen more quickly, leaving the United States with a substantial net foreign debt.
Source: U.S. Department of Commerce, Bureau of Economic Analysis, June 2010.
316 PART THREE Exchange Rates and Open-Economy Macroeconomics
stocks of wealth reflects the rapid globalization of financial markets in the late 20th
century, a phenomenon we will discuss further in Chapter 21.
Think about how wealth positions of this magnitude amplify the effects of exchange
rate changes, however. Suppose that 70 percent of U.S. foreign assets are denominated in
foreign currencies, but that all U.S. liabilities to foreigners are denominated in dollars
(these are approximately the correct numbers). Because 2009 U.S. GDP was around $14.4
trillion, a 10 percent depreciation of the dollar would leave U.S. liabilities unchanged but
would increase U.S. assets (measured in dollars) by percent of
GDP, or about $1.3 trillion. This number is approximately 3.5 times the U.S. current
account deficit of 2009! Indeed, due to sharp movements in exchange rates and stock
prices, the U.S. economy lost about $800 billion in this way between 2007 and 2008 and
gained a comparable amount between 2008 and 2009 (see Figure 13-2). The corresponding
redistribution of wealth between foreigners and the United States would have been
much smaller back in 1976.
Does this possibility mean that policy makers should ignore their countries’ current
accounts and instead try to manipulate currency values to prevent large buildups of net
foreign debt? That would be a perilous strategy because, as we will see in the next chapter,
expectations of future exchange rates are central to market participants’ behavior.
Systematic government attempts to reduce foreign investors’ wealth through exchange
rate changes would sharply reduce foreigners’ demand for domestic currency assets, thus
decreasing or eliminating any wealth benefit from depreciating the home currency.
0.1 * 0.7 * 1.29 = 9.0
SUMMARY
1. International macroeconomics is concerned with the full employment of scarce economic
resources and price level stability throughout the world economy. Because they
reflect national expenditure patterns and their international repercussions, the national
income accounts and the balance of payments accounts are essential tools for studying
the macroeconomics of open, interdependent economies.
2. A country’s gross national product (GNP) is equal to the income received by its factors of
production. The national income accounts divide national income according to the types of
spending that generate it: consumption, investment, government purchases, and the current
account balance. Gross domestic product (GDP), equal to GNP less net receipts of factor
income from abroad, measures the output produced within a country’s territorial borders.
3. In an economy closed to international trade, GNP must be consumed, invested, or purchased
by the government. By using current output to build plant, equipment, and
inventories, investment transforms present output into future output. For a closed
economy, investment is the only way to save in the aggregate, so the sum of the saving
carried out by the private and public sectors, national saving, must equal investment.
4. In an open economy, GNP equals the sum of consumption, investment, government
purchases, and net exports of goods and services. Trade does not have to be balanced if
the economy can borrow from and lend to the rest of the world. The difference
between the economy’s exports and imports, the current account balance, equals the
difference between the economy’s output and its total use of goods and services.
5. The current account also equals the country’s net lending to foreigners. Unlike a closed
economy, an open economy can save by domestic and foreign investments. National
saving therefore equals domestic investment plus the current account balance.
6. Balance of payments accounts provide a detailed picture of the composition and financing
of the current account. All transactions between a country and the rest of the world are
recorded in the country’s balance of payments accounts. The accounts are based on the
convention that any transaction resulting in a payment to foreigners is entered as a debit
while any transaction resulting in a receipt from foreigners is entered as a credit.
7. Transactions involving goods and services appear in the current account of the balance of
payments, while international sales or purchases of assets appear in the financial
account. The capital account records mainly nonmarket asset transfers and tends to be
small for the United States. The sum of the current and capital account balances must
equal the financial account balance (net financial flows). This feature of the accounts
reflects the fact that discrepancies between export earnings and import expenditures must
be matched by a promise to repay the difference, usually with interest, in the future.
8. International asset transactions carried out by central banks are included in the financial
account. Any central bank transaction in private markets for foreign currency assets is
called official foreign exchange intervention. One reason intervention is important is that
central banks use it as a way to change the amount of money in circulation. A country has
a deficit in its balance of payments when it is running down its official international
reserves or borrowing from foreign central banks; it has a surplus in the opposite case.
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