International Finance Theory and Policy Analysis Term Paper

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Gross Domestic Product (GDP) is a way to assess the strength of an economy. Basically, it is the end value of all the things produced in our country. For example, the end value of a bushel of wheat (i.e. The amount of money, in USD, that a bushel of wheat 'converts to' when purchased as bread, or cereal, etc., by consumers), probably multiplied by how many of bushels of wheat were produced in that year, would be used in factoring GDP. While GDP is certainly a method of assessing the strength of the economy, it is not without its pitfalls.

GDP is calculated by simply adding a number of other calculations together: the value of all the things we have consumed (including foreign goods), the value of all investments by private domestic businesses, the value of government expenditures (i.e. government worker salaries), and exports. Imports are subtracted from this list. This equation is known as the national product identity.

Imports are subtracted from GDP for this reason, and this reason alone: imports come to the U.S. And are then purchased by consumers, businesses, and the government. These expenditures are included in the national product identity. However, they do not in reality represent a product of the U.S., so their total value must be subtracted from GDP, otherwise GDP would appear larger than it actually is.

When the U.S.' GDP is broken down into its component parts, consumption expenditures make up the bulk of it, followed by investment expenditures. A noteworthy aspect of investment expenditures is that they 'should' be a measure of future economic growth. This is because investment expenditures represent money put into the creation of new product, or as the text calls it, capital. Thus, the amount of investment expenditures for one year should give us an idea of how much a country will grow in the upcoming years. However, this formula has been shown unreliable.

The balance of payments accounts is basically exports minus imports.

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What this really refers to is the net value of transactions between residents of two countries. The balance of payments accounts is divided into four categories (of which exports and imports exist): current account -- international transactions of goods and services; merchandise trade account -- international transactions of goods; services account -- international transactions of services; and financial account -- international transactions of assets.

Recording transactions on the balance of payments is done in a fairly simple way. All exports are treated as 'credit,' and in effect add to the balance of payments, and all imports are treated as 'debit,' and in effect subtract from the balance of payments. Theoretically, recording transactions on the balance of payments should result in zero, with goods and services bought always being canceled by financial assets sold, and the other way around. However, because of gaps in accounting, economists must use a statistical discrepancy figure to balance transactions correctly.

Through a number of diagrams, the text attempts to explain the Twin Deficit Identity, which is the relationship of a government's budget deficit with a nation's current account deficit. The twin deficit identity can be summarized as this: the net of private savings (firms' profits) minus private investments (financial institutions' 'savings') plus the net of value of imports (which private firms purchase) minus exports (which private firms sell) equals the net of government spending (on the goods and services of private firms) plus tax revenue (made to households) minus taxes (paid for by firms).

A country's international investment postion is basically a reading of if the country is 'in debt' (a 'debtor' nation) or 'in the green' (a 'creditor' nation). The U.S. is the biggest 'debtor' nation of them all, but this does not necessarily mean that the country is in the worst position, in terms of international investment, of them all.

Chapter 6

Trade deficits and trade surpluses are not to be….....

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