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National Income, BOP
Accounting and Central
Banking
Monetary Theory and Policy
UFM
Summer, 2006
1. National Income Accounting

Y = C + I + G + CA
S=Y–C–G

Sp = I + CA – Sg = I + CA – (T – G) = I + CA +
(G – T)


Private saving (Sp): The part of disposable
income that is saved rather than consumed
T is the government's “income” (its net tax
revenue)
Sg is government savings (T-G)
Four different ways to describe
the current account:




(CA  B *  B*1 )
a. change in net foreign assets
b. national saving net of investment (CA  S  I )
c. income minus absorption
(CA  Y  A)
d. trade balance plus net factor payments from abroad
absorption approach, elasticity approach

Issues:
*Causes of current account deficit
*Adding up the world CA is not equal to 0?
(CA  X  IM  NF )
2. The Balance of Payments
Accounts






CA
CA
CA
CA
+
+
+
+ FA
FA
=
0
FA
+
OSA =
0
FA
=
BOP
+ KA + S & O + OSA =
0
A country’s balance of payments accounts keep
track of both its payments to and its receipts
from foreigners.
Every international transaction automatically
gives rise to two offsetting entries in the balance
of payments resulting in a fundamental identity :
once as a credit (+) and once as a debit (-).
The Balance of Payments Accounts



THE BALANCE OF PAYMENTS is a record of all transactions
between domestic residents and the rest of the world.
Examples: goods and services, license fees, interest income,
dividends, real assets (factories, land), financial assets
(stocks, bonds, bank deposits, loans), unilateral transfers
(foreign aid, private gifts).
Rule:
Sell something to rest of world, receive payment enters
as credit (+).
Buy something from rest of the world, make payment 
enters as debit (-).
Think: all international transactions require foreign
currency. All credit transactions give rise to supply of
foreign exchange. All debit transactions give rise to
demand for foreign exchange.
The Balance of Payments Accounts
 Three
types of international
transactions are recorded in the
balance of payments:
– Exports or imports of goods or services
recorded in the current account
– Purchases or sales of financial assets
recorded in the financial account
– Transfers of wealth between countries
recorded in the capital account.
The Balance of Payments Accounts

Examples of Paired Transactions
– A U.S. citizen buys a $1000 typewriter from an
Italian company, and the Italian company
deposits the $1000 in its account at Citibank in
New York.
 That
is, the U.S. trades assets for goods.
 This transaction creates the following two offsetting
entries in the U.S. balance of payments:
– It enters the U.S. CA with a negative sign (-$1000).
– It shows up as a $1000 credit in the U.S. financial
account.
The Balance of Payments Accounts
– A U.S. citizen pays $200 for dinner at a
French restaurant in France by charging
his Visa credit card.
 That
is, the U.S. trades assets for services.
 This transaction creates the following two
offsetting entries in the U.S. balance of
payments:
– It enters the U.S. CA with a negative sign (-$200).
– It shows up as a $200 credit in the U.S. financial
account.
The Balance of Payments Accounts
– A U.S. citizen buys a $95 newly issued share of
stock in the United Kingdom oil giant British
Petroleum (BP) by using a check drawn on his
stockbroker money market account. BP
deposits the $95 in its own U.S. bank account
at Second Bank of Chicago.
 That
is, the U.S. trades assets for assets.
 This transaction creates the following two offsetting
entries in the U.S. balance of payments:
– It enters the U.S. financial account with a negative sign
(-$95).
– It shows up as a $95 credit in the U.S. financial
account.
CA: 4 components

Commodity
Service
Factor Income
Unilateral Transfer
Issues:
*Net international investment position (ex. USA)
*Negative 5% is the threshold for currency crisis
*Persistent, sustainable, excessive, and solvent
*A mirror of FA
*International risk portfolio diversification
*Stock and flow view of CA
FA: 3 components

Foreign Direct Investment
Portfolio Investment (stock and bond)
Other Investment (bank loans)

Issues:
*Liberalization of FA
*Pace, sequence, volume of capital mobility
*Policy response to capital inflow
*Economic growth and types of capital flow
*Components of FA and its effect on CA (S & I)
*M&A (Merger and Acquisition)
*Pension fund, mutual fund, and hedge fund
*Capital account crisis
OSA: (-BOP)

Change of foreign reserves

Issues:
*BOP crisis
*Over-holding of foreign reserves (3-6 months of
imports): cost and benefit (ex. Asian
countries after crisis)
*Flow and stock (total reserves minus gold)
3. Central Bank Balance Sheet
B  D  NFAcb


B: monetary base, includes currency and
commercial bank reserves or deposits at the
central bank.
D: domestic credit, includes US treasury debt and
discount lending
NFAcb: foreign exchange reserves
Issues:
*Central Bank’s Balance Sheet
*Holding reserves
*Foreign exchange market intervention
*Sterilization
*Monetization of government debt