National Economic Accounts and the Balance of Payments

The national income identity for a closed economy

Y = C + I + G

where

Y = output

C = private consumption

I = investment

G = government purchases of goods and services

Net exports (X – M) is the equivalent of the current account balance from a BOP perspective.

M > X, the current account is in deficit

M < X, the current account is in surplus.

The current account balance from the perspective of the national income accounts

CA = X – M = Y – (C + I + G)

If a country consumes more output than it produces, it has a current account deficit and borrows money from foreigners .

If it consumes less output than it produces, it has a current account surplus and can (indeed must) lend the surplus to foreigners.

An economy with a current account deficit is effectively importing present consumption and exporting future consumption.

Disposable income

Y^d = Y + R – T

where

R = net transfers

T = taxes

Disposable income

Y^d = C + S_p

where

S_p = private sector saving

C = Y^d – S_p = Y + R – T – S_p

CA = S_p – I + (T – G – R)

(T – G – R) is taxes minus government spending and transfers, it is the government surplus

S_p + S_g = I + CA

An open economy can use its saving for domestic investment or for foreign investment.

S_p = I + CA – S_g

An economy’s private savings can be used in three ways: (1) investment in domestic capital (I), (2) purchases of assets from foreigners (CA), and (3) net purchases (or redemptions) of government debt (–S_g).

CA = S_p + S_g – I

A current account deficit tends to result from low private savings, high private investment, or a government deficit (Sg < 0).

A current account surplus reflects high private savings, low private investment, or a government surplus.

If a trade deficit primarily reflects strong investments (I), the deficit country can increase its productive resources and its ability to repay its liabilities.

Current account deficit, strong domestic economy, elevated domestic credit demand and high interest rates, growing net capital imports, appreciating currency. In the long run, lead to a depreciating currency.