Topic14_A_BOP_AAP_B&W6

Topic14_A_BOP_AAP_B&W6 - Key Concepts Open Economy...

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Unformatted text preview: Key Concepts Open Economy Macroeconomics I • • • Balance of Payments (BOP) accounting BOP is always in balance! The GDP identity GDP Implications Open Economy Accounting or BOP Capital Markets in an Open Economy Topic 14-A (Text: 5.1-5.3, 5.5; Article 23) 1 An “International” Policy Question International” • In 2007 we had ~ $292 billion BOP deficit with the PRC (China)! China bought U.S. assets (reserves) with $222 of it Total BOP deficit was $718 billion 7 BOP • BOP keeps track of payments to and receipts from foreigners Goods, services, asset transactions • BOP is equivalent to a Cash Flow Statement • U.S. net foreign indebtedness is $2.44 trillion We own $17.6 tri. “they” own $20.1 tri. they” In 2008 total U.S. assets purchased by foreign countries ~ $600 billion (from $2.1 trillion) Many different accounts Transactions enter twice (debit and credit) • There is no “profit” or “loss” but there is profit” loss” there deficit and surplus surplus • Should the U.S. do something about it? 3 Economic Connections to the World How are we connected to the rest of the world economically? 8 Credit/Debit • “Sources of funds” are credits (+ sign) funds” Receipts from foreigners • “Uses of funds” are debits (- sign) funds” (Payments to foreigners • Sources and uses always match => BOP is always in balance! • To talk about a BOP surplus or deficit we BOP must leave something out from the BOP BOP Official reserve transactions for example 5 9 1 1 Capital Account Categories BOP Accounting 1. Current account (+ or -) a) b) c) d) • Changes in U.S. holdings of foreign assets Exports (+) Computers, planes, services Imports (-) Cars, TV sets, … (Interest & dividends paid and received Net Transfers (+ or -) Foreign workers Official reserve assets Generally foreign currency denominated Other (private) assets 2. Capital account (+ or -) Increase is (-); outflow of $s (- a) Increase in US holdings of foreign assets (-) Increase (- • Changes in foreign holdings of U.S. assets Purchases of foreign securities, lending, building facilities (DFI) (DFI) b) Increase in Foreign holdings of US assets (+) Increase Official reserve assets Generally $ denominated Portfolio investment, T. Bills & Bonds, foreign borrowing Other (private) assets 3. Statistical discrepancy (+ or -) Balance => 1 + 2 + 3 = 0 Increase is (+); inflow of $s 10 15 Current Account Categories The Components • Exports & Imports: U.S. Merchandise Balance $ Billion, Annualized, SA 100 0 1960:I 1963:I 1966:I 1969:I 1972:I 1975:I 1978:I 1981:I 1984:I 1987:I 1990:I 1993:I 1996:I 1999:I 2002:I 2005:I 2008:I -100 Merchandise (physical goods) Services -200 -300 -400 -500 -600 Tourists’ expenditures, shipping & insurance, Tourists’ financial services, consultancy, education • Investment income received (+) or paid (-) (e.g., interest payments, dividends -700 -800 -900 -1,000 U.S. Service Balance $ Billion, Annualized, SA 160 140 120 100 80 60 40 20 0 19 60 : 19 I 63 : 19 I 66 : 19 I 69 : 19 I 72 : 19 I 75 : 19 I 78 : 19 I 81 : 19 I 84 : 19 I 87 :I 19 90 : 19 I 93 : 19 I 96 : 19 I 99 : 20 I 02 : 20 I 05 : 20 I 08 :I -20 11 17 Current Account Categories (cnt.) cnt.) The Components U.S. Income Balance $ Billion, Annualized, SA 160 140 • Net Unilateral Transfers 120 Foreign workers in the US US workers in foreign countries 100 80 60 40 20 0 -20 19 60 : 19 I 63 : 19 I 66 :I 19 69 : 19 I 72 : 19 I 75 : 19 I 78 : 19 I 81 : 19 I 84 : 19 I 87 : 19 I 90 : 19 I 93 : 19 I 96 : 19 I 99 :I 20 02 : 20 I 05 : 20 I 08 :I Not related to the transfer of any good or service, nor payments on investments Money workers earn abroad and send to dependents in their home country U.S. Indebtedness; $ Billion 20,000 18,000 U.S.-Owned Assets Abroad 16,000 Foreign-Owned Assets in the U.S. 14,000 12,000 Foreign or military aid 10,000 8,000 6,000 4,000 2,000 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 0 12 18 2 2 Statistical Discrepancy Reserves Account • We know that: Current Account (CA) + Capital Account (CapA) = 0 • The statistical discrepancy can be large ($100 B!) • For many reasons, there will always be statistical discrepancies • Reserves account = Changes in Net official Changes reserves held by the central bank Delays in the reporting of transactions Some forget to report foreign income Generally only one side of the transactions is measured Also: • Reserves account = Current account + Non-reserve capital Nonaccount • There are many informal definitions of “CA Deficit” Deficit” Often a BOP deficit or surplus means the BOP changes in the Reserves Account These discrepancies can be large and variable 21 24 The CA and the Cap. Acct CA Cap. BOP Deficit (cnt.) cnt.) • Every transaction initiated in the current initiated account gives rise to a transaction on the capital account • What does it mean to say: the US CA deficit CA was $668 billion in 2005? Barter is extremely rare All transactions are financed • For example, a U.S. resident imports a BMW from Germany for $35,000 $35T appears as merchandise import on the CA CA $35T appears as foreign holdings of U.S. assets on the CapA CapA This is the loan or credit 22 27 BOP Example #2 Transactions On the Cap. Acct. Cap. • A transaction initiated in the capital account initiated will generally not have a counterpart on the not current account • For example, a US investor buys 10M € for $15.3M $15.3M appears as of US holdings of foreign assets (DM) $15.3M appears as of Foreign holdings of US assets 23 Example (page 202, question 1) Merchandise exports Merchandise imports Service exports Service imports Income receipts from abroad Income payments to foreigners Increase in home country’s ownership country’ of foreign assets Increase in foreign ownership of home country assets Increase in home reserve assets Increase in foreign reserve assets = 100 = 125 = 90 = 80 = 110 = 150 = 160 = 200 = 30 = 35 32 3 3 BOP Example #2 Open Economy Accounting (cnt.) cnt.) Find the merchandise trade balance, NX, CA, the merchandise NX CA capital and financial account balance, the statistical discrepancy and the official settlements balance Merchandise Trade balance = NX = CA = Cap. A = Statistical discrepancy = Official Settlements balance = • Total income is spent: Y + TR + INT = C + T + Sp where: TR INT TR is government transfers INT is net interest received (+) T is tax paid Sp is private savings 33 BOP Deficit 37 Open Economy Accounting (cnt.) cnt.) (cnt.) cnt.) • Why do we care? In general, persistent deficits may indicate an may overvalued currency or other imbalances It always means either a decline in foreign assets, or an increase in foreign indebtedness It depends on the FX regime FX If floating it may imply a future depreciation of the FX rate FX If fixed, gov. loses foreign reserves, can precipitate a gov. crisis • Combine the two relations by substituting out Y: C + Sp + (T - TR) - INT = C + I + G + NX NX • Eliminate C and rearrange to get a very important identity Analysts often ignore this when they discuss economic policy Are deficits bad? 35 38 Open Economy Accounting Open Economy Accounting (cnt.) cnt.) • In a closed economy, Y=C+I+G • In an open economy, the national income identity is Y = C + I + G + NX NX • Combine the two relations by eliminating Y: C + Sp + (T - TR) - INT = C + I + G + NX NX where NX is net exports (exports – imports of G&S) NX • Eliminate C and rearrange to get a very important identity identity Analysts often ignore this when they discuss economic policy S p I G TR T NX INT Priv. Inv. Savings 36 Budget Deficit CA Surplus 39 4 4 Open Economy Accounting (concl.) concl.) • Combine private & government savings and rearrange to get Snatl = I + CA CA where Snatl is “national savings” savings” Capital Market (cnt.) cnt.) • In a small open economy it follows that the open domestic interest rate equals the world interest rate (rw). (Why?) A small economy takes the world interest rate as given • How is the world interest rate determined? Is the US a “small economy”? economy” 40 OE Accounting Example 44 Capital Market • Let Sp = 600, I = 800, Gov. Deficit = 100. Gov. What does CA have to be? CA Snat’l = I + CA CA nat’ (cnt.) cnt.) • The Cap.A (and therefore CA) is determined by the Cap.A CA difference between saving and investment at the world interest rate world Depending on the domestic S and I curves and the prevailing world interest rate, an economy can have a zero, positive, or negative trade balance • Some applications: Is a larger trade deficit necessarily bad? Suppose the investment opportunities in an economy expand. The investment curve shifts outward and the deficit worsens. (A leftward shift in S has the same effect) 41 Capital Market in an Open Economy • In a closed economy, the capital market equilibrium is just Sd = I d • The home supply of loanable funds has to equal the home demand for loanable funds, and the home interest rate adjusts to clear the capital market • In an open economy, the country as a whole can borrow if its citizens do not save enough to meet domestic investment demand. Sd could be less than Id, and CA could be negative CA (exports < imports) Sd - Id = CA CA 43 45 Capital Markets (cnt.) cnt.) • More applications: Does a budget deficit lead to a trade deficit? In the 80s both deficits were high leading to theories that the twin deficits were connected. In the traditional view, a budget deficit financed by tax cut decreases saving, which in turn worsens the trade deficit Note, the Ricardian argument against this view – there, the national saving is unchanged and so is the trade deficit An increase in the world interest rate (say due to a decrease in funds supplied to the market by some large economies) will cause a decrease in the trade deficit of a small open economy 46 5 5 Glossary S I TR T G INT I NX CA Saving Investment Government transfers Taxes Government expenditures (purchases) Net interest & dividend payments received from abroad Investment Net exports Current Account 47 THE END 48 6 6 ...
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