31/01/17 Open economy national income identities
and the balance of payments
Motivations:
• 
Global imbalances and the US current account deficit
• 
Current account imbalances and the euro zone crisis
• 
Current accounts of emerging markets: the next crisis?
• 
Is there an “exorbitant privilege” of the dollar?
Roadmap:
1)  Open economy accounting (review)
2)  Balance of payments and the net foreign wealth
3)  Valuation effects, the exorbitant privilege and the
adjustment mechanisms to global imbalances
Open economy national income identities : Saving,
investment and the current account
•  Fondamental identity
Y= C + I + G + EX - IM
• 
• 
• 
• 
• 
• 
• 
Y: GDP
C: Consumption
I: Investment
G: public spending
EX: Exports of goods and services
IM: Imports
Current account (sometimes net exports):
CA= EX-IM
1 31/01/17 GDP and GNP In international
accounting standards
•  GDP (Gross Domestic Product): value of all final goods
and services produced within national borders (on a
given period)
•  GNP (Gross national product): value of all final goods
and services produced by national factors of production
(on a given period)
•  GNP = GDP + net receipts of factor income from the
ROW; (income domestic residents earn on wealth held in
ROW – payments domestic residents make to foreigners
who own wealth located in domestic economy)
•  Usually small difference (except Ireland, GNP much
smaller than GDP because of multinationals)
•  Here, we focus on GDP : + mostly ignore net factor
payments (GNP-GDP)
Fondamental identity for US, France, China 2015
Y(GDP)= C+I+G+EX-IM; (€/$ ≈ 1.07)
France in billions €
Y: 2181
US in billions $ (% of GDP)
Y: 18 567
C: 1202 (55.1%)
C: 12 751 (68.7%)
I: 488 (22.4%)
I: 3037 (16.3%)
G: 522 (24.0%)
G: 3279 (17.7%)
EX: 655 (30.0%)
EX: 2232 (12.0%)
IM: 685 (31.4%)
IM: 2732 (14.7%)
CA= EX-IM= - 30 (-1.4%)
CA= -500 (-2.7%)
China: C=38.6% % G=13.8% I= 44.7 % ; X=22.1%; IM=18.6%
GDP (9962 billions$)
2 31/01/17 Saving, investment and the current account
S = Y- C – G
and
Y = C + I +G +EX -IM
S+Y=Y-C-G+C+I+G+EX-IM
so
S - I = EX - IM = CA or I = S - CA
-  a country can finance its investment through
domestic saving or through borrowing abroad if CA <
0 (net external debt increases: sale of assets to
ROW)
- Saving can be invested nationally (I) or abroad (if
CA > 0; purchase of assets to ROW):
Budget deficit and current account
Private saving: SP = Y - T - C
Public saving: SG = T - G (budget deficit if <0 )
Y = C + I + G + EX –IM
so
SP = C + I + G + EX -IM - T – C
so
SP = I + G + EX - IM - T or
CA = EX - IM = SP - I + SG = S -I
Deficit of the current account if <0
3 31/01/17 Budget deficit and current account
CA = EX - IM = SP - I +T - G = S - I
Accounting identity (no behaviour, no explanation, no theory here)
A current account deficit can reflect:
- low saving rate (high consumption) (US from 2000, Spain)
- High investment (US 1995-2000, Spain)
-  budget deficit (Greece) and « twin deficits», Reagan years (but G may
SP : ricardian equivalence)
-  current account surplus can reflect recession (Spain after crisis)
-  current account surplus may reflect large saving or restrictive fiscal policy
(Germany)
NOTE: tariffs don’t matter (≠ Trump economics)
4 31/01/17 China: CA = S -I
Global imbalances have increased before crisis and then decreased:
Current account balances (in percent of world GDP)
Source IMF 2014
5 31/01/17 Eurozone imbalances have increased before crisis and then disappeared:
Current account balances (in percent of eurozone GDP)
Source IMF 2014
Saving and Investment Trends (in percent of domestic GDP)
6 31/01/17 « Good » and « bad » imbalances
no obvious normative judgement on sign (if not size) of CA
« Good » imbalances:
S > I : aging countries (anticipation of later dissaving)
I > S : high return to investment: finance part of I through
foreign saving
But no if reflects:
Domestic Distortions
-  High private saving (China) : lack of social insurance
-  Low private saving (US): asset bubbles (real estate, Spain)
-  Public borrowing (disaving) or excessive public saving (if
sustained CA surplus): political economy distortions
Current accounts and net foreign asset
Accumulating CA deficits leads to a negative NFA (net foreign
assets) position with the ROW (also called Net international
investment position (NIIP)
Accounting (forget capital gains and losses, valuation effects):
If a country in year t has a CA deficit, its net external position
(or NFA) Bt deteriorates:
CAt = Bt - Bt-1
Flow
Net external position (NFA) in t is NFA in t-1 + CA value
Stock (wealth): Bt = Bt-1 + CAt
Bt < 0 if debtor country: value of the foreign assets it holds <
value of domestic assets held by foreigners
7 31/01/17 NFA Projections (in percent of world GDP)
US as largest debtor country
IMF
Debtor and creditor countries (in % of domestic GDP)
8 31/01/17 Balance of Payments (BOP)
- Registers all transactions with foreign economic
agents
- 3 main sorts of transactions:
- exports and imports of goods and services:
current account
- sale and purchase of financial assets (money,
equity, public or private debt): financial account
- certain transfers of wealth (small): capital
account
All transactions enter twice in the BOP: once in debit (-)
and once in credit (+)
Three types of transactions:
1) Exports (+) and imports (-) of goods and services:
current account
2) Sale (+) and purchase (-) of financial assets (like
exports and imports of financial assets):
Financial account
3) Some wealth transfers (migrants, debt copyrights…):
small amounts
Capital account
9 31/01/17 Double entry bookkeeping: example
•  A French firm buys machinery from a
German firm (1M€)
–  Payment of French firm to foreign resident
goes in negative in current account (-1M€)
–  Check of French firm to German firm
deposited in French bank: German firm has
bought (and French Bank has sold) an asset
(a bank deposit of 1M€) : shows in positive in
French financial account
Fundamental balance of payments identity
Current account + Capital account + Financial account = 0
Sum of current account (CA)+ capital account (KA) is the
change in NFA : hence necessarily it is the opposite of
the financial account
A country with CA +KA <0 has to sell (export) assets
abroad . Financial account in surplus. NFA deteriorates
A country with CA+KA>0 (S>I) buys (imports) assets
abroad. Financial account in deficit. NFA improves
10 31/01/17 Line
US Balance
of payments
2015
CA+KA+FA+ stat. disc. = 0
In billions$
-463-0+195+268 =0
2015
Current account
Exports of goods and services and income receipts (credits)
3172693
Exports of goods and services
2261163
Goods
1510303
Services
750860
Primary income receipts
782915
Investment income
775846
Compensation of employees
7069
Secondary income (current transfer) receipts /1/
128614
Imports of goods and services and income payments (debits)
3635658
Imports of goods and services
2761525
Goods
2272868
Services
488657
Primary income payments
600531
Investment income
582466
Compensation of employees
18065
Secondary income (current transfer) payments /1/
273602
Capital account
17
Capital transfer receipts and other credits
0
18
Capital transfer payments and other debits
42
Financial account
19
Net U.S. acquisition of financial assets excluding financial derivatives (net increase
225398in assets / financial outflow (+))
20
Direct investment assets
348646
21
Portfolio investment assets
153968
22
Other investment assets
-270924
23
Reserve assets
-6292
24
Net U.S. incurrence of liabilities excluding financial derivatives (net increase 395234
in liabilities / financial inflow (+))
25
Direct investment liabilities
379435
26
Portfolio investment liabilities
250936
27
Other investment liabilities
-235137
28
Financial derivatives other than reserves, net transactions /2/
-25392
Statistical discrepancy
29
Statistical discrepancy /3/
267780
29a
Of which: Seasonal adjustment discrepancy
.....
Balances
30
Balance on current account (line 1 less line 9) /4/
-462965
31
Balance on goods and services (line 2 less line 10)
-500361
32
Balance on goods (line 3 less line 11)
-762565
33
Balance on services (line 4 less line 12)
262203
34
Balance on primary income (line 5 less line 13)
182385
35
Balance on secondary income (line 8 less line 16)
-144988
36
Balance on capital account (line 17 less line 18) /4/
-42
37
Net lending (+) or net borrowing (-) from current- and capital-account transactions
-463007
(line 30 plus line 36) /5/
38
Net lending (+) or net borrowing (-) from financial-account transactions (line -195227
19 less line 24 plus line 28) /5/
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
2011
2012
Compte de transactions courantes
Biens
Services
Revenus
Transferts courants
-35.2
-76.6
31.5
45.1
-35.2
-44,4
-70.6
32.6
29.7
-36.2
Compte de capital
0.03
-0.4
53.6
-15.1
-42.8
27.7
228.5
166.6
61.9
13.9
-179.3
5.5
74.2
-9.4
-28.9
19.5
39.2
6.3
32.9
14.3
34.1
-4.0
-18.4
-29.4
Compte financier
Investissements directs
Français à l'étranger
Etrangers en France
Investissements de portefeuille
Avoirs (résidents sur titres émis par des non-résidents)
Engagements (non-résidents sur titres émis par résidents)
Produits financiers dérivés
Autres investissements
Avoirs de réserve
Erreurs et omissions nettes
Source: banque de France
11 31/01/17 Valuation effects and the exorbitant
privilege of the US $
•  CA deficits only one factor of the evolution of the
NFA position
•  Valuation effects have become very large due to
financial globalization and the increase in gross
positions (assets and liabilities)
•  Bt - Bt-1 = CAt + Change in capital gains
•  Change in exchange rate and/or movements in
equity markets affect value of both foreign assets
held by domestic agents (assets) and domestic
assets held by foreign agents (liabilities)
Valuation effects and the US
deficits
•  Growing divergence between accumulation of CA deficits
and NFA position in US
•  Period 2002-2006: with CA deficits (>5% of GDP) the US
NFA position (measures the difference between the value
of foreign assets held by US agents and US assets held
by foreigners) barely changed: cumulative of CA deficits
around $3.4 trillion ⇒ should have raised US net external
liabilities to some $5.5 trillion (40% of GDP). The NFA
deterioration was only $400 billion. As a ratio of GDP it
actually improved.
•  Where did those other $3 trillion of US net borrowing go?
12 31/01/17 US: Cumulated Current Account and Net Foreign Asset
Position, Percent of GDP
US becomes net foreign
debtor
Source: Gourinchas and Rey 2013
Bureau of Economic Analysis 2008
13 31/01/17 How can that be?
•  Foreign assets held by Americans (mostly
denominated in foreign currency) increased in
value much more than foreign-held assets in the
US (mostly denominated in $): why?
•  $ depreciation 2002-2007
A numerical example and the role of the $
• 
• 
• 
• 
NIIP or NFA of US in 2002 ≈ 20% of GDP
Foreign assets held in the US ≈ 125% GDP
US held by foreigners ≈ 145% GDP
Around 65% of foreign assets held by US
are in foreign currency (euro, yen…)
•  Around 95% of US assets held by foreigners
are in $
14 31/01/17 •  $ depreciates by 10% (other currencies appreciate
by 10%)
•  Foreign assets (in foreign currency) gain: (0.1)
(0.65)(1.25) = 8,1% of US GDP
•  US assets (in foreign currency) held by foreigners
gain : (0.1)(.05)(1.45) = 0.7% of US GDP
•  In net: the net value of US debt to ROW decreases
by 7,4% of US GDP (a transfer of more than $
1000 billions to U.S!)
•  If (big if) repeated: can suggest that due to dollar
role (US debt in dollar) foreigners get a weak
return on American assets: « exorbitant privilege »
•  But $ appreciates these days…
How large is the« exorbitant privilege»?
Gourinchas and Rey (2005): From world banker to world
venture capitalist: US external adjustment and the
“exorbitant privilege”’
Total return on US assets held by foreigners (the US debt)
<
Return on foreign assets held by foreigners since 1971 (end
of Bretton Woods)
-  US borrow at 3.5% and lend or invest ar 6.8% important
differentiel :
–  3.3%!: (huge) exorbitant privilege ; both a composition
effect (assets are riskier and less liquid than liabilities)
and a return effect (excess return within class of assets)
15 31/01/17 - Returns are not equated even within classes (no arbitrage)
-  could be that assets and liabilities of US of different maturities
-  role of dollar as reserve currency + liquidity of US financial markets(?):
foreigners are willing to hold underperforming US assets because more liquid
(exorbitant privilege or dark matter)
-  composition effect: assets are in risky/high return (equity/fDI), liabilities are in
low returns bonds: does not play very important role
16