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figure 41.1

The Balance of Payments Payments to the rest of the world for assets
The green arrows represent payments that are
counted in the current account. The red arrows Payments to the rest of the world for goods
represent payments that are counted in the fi- and services, factor income, and transfers
nancial account. Because the total flow into
the United States must equal the total flow out
of the United States, the sum of the current ac- United Rest of
count plus the financial account is zero. States world

Payments to the United States for goods
and services, factor income, and transfers

Payments to the United States for assets

that the sum of the red and green arrows going into the United States is equal to the
sum of the red and green arrows going out of the United States. That is,

(41-2) Positive entries on the current account (lower green arrow) + Positive
entries on the financial account (lower red arrow) = Negative entries
on the current account (upper green arrow) + Negative entries on the
financial account (upper red arrow)

Equation 41-2 can be rearranged as follows:

(41-3) Positive entries on the current account − Negative entries on the current
account + Positive entries on the financial account − Negative entries on
the financial account = 0
fyi

GDP, GNP, and the Current Account
When we discussed national income account- U.K. aren’t included in America’s GDP, and the
ing, we derived the basic equation relating GDP funds Latin American immigrants send home to
to the components of spending: their families aren’t subtracted from GDP.
Shouldn’t we have a broader measure that
Y = C + I + G + X − IM
does include these sources of income? Actually, Michael Newman/Photo Edit
where X and IM are exports and imports, respec- gross national product—GNP—does include in-
tively, of goods and services. But as we’ve ternational factor income. Estimates of U.S. GNP
learned, the balance of payments on goods and differ slightly from estimates of GDP because
The funds Latin American immigrants send home
services is only one component of the current ac- GNP adds in items such as the earnings of U.S. through Western Union wires, as advertised on
count balance. Why doesn’t the national income companies abroad and subtracts items such as this billboard, aren’t subtracted from GDP.
equation use the current account as a whole? the interest payments on bonds owned by resi-
The answer is that gross domestic product, dents of China and Japan. There isn’t, however, production rather than income. Second, data on
which is the value of goods and services pro- any regularly calculated measure that includes international factor income and transfer payments
duced in a country, doesn’t include two sources of transfer payments. are generally considered somewhat unreliable. So
income that are included in calculating the current Why do economists use GDP rather than a if you’re trying to keep track of movements in the
account balance: international factor income and broader measure? Two reasons. First, the original economy, it makes sense to focus on GDP, which
international transfers. The profits of Ford Motors purpose of the national accounts was to track doesn’t rely on these unreliable data.

414 section 8 The Open Economy: Inter national Trade and Finance