4 video Balance of payments and current account Flashcards
Current account definition?
The current account records a nation’s transactions with the rest of the world—specifically its net trade in goods and services, its net earnings on cross-border investments, and its net transfer payments—over a defined period, such as a year or a quarter
Fine more solid definition
Current account surplus:
1. You have strong competitiveness, and you export a lot, more than you import
2. High domestic desire to save
If you have constantly current account deficit, you currency tends to depreciate. (Dollar is an exception kind off, because its standard global currency)!
The Ricardian equivalence? Important concept to know
?
The balance of payments?
?
Consumer Intertemporal optimization formula? 6.3
max c -> [u(Ci)+βu((1+r)(y−c)+y)]
max c: This symbol indicates that we are maximizing the expression with respect to the variable c, which typically represents consumption.
u(Ci): This term represents the utility function for the current period, where Ci is the consumption in the current period.
β: This is a discount factor, which reflects the individual’s preference for consumption in the current period compared to consumption in the future. It is a value between 0 and 1.
u((1+r)(y−c)+y): This term represents the utility function for the next period, where y is the income, c is the consumption in the current period, r is the discount rate, and
(1+r)(y−c)+y represents the future consumption discounted to its present value.
GNP? 6.9
Gross national product (GNP) is an estimate of the total value of all the final products and services turned out in a given period by the means of production owned by a country’s residents
GNP measures the output of a country’s residents regardless of the location of the actual underlying economic activity
While GDP = Y
GNP = Y + rB
B= foreign assets - foreign liabilities
Net foreign asset position? (NFA) 6.10
Usually measured as % of GDP
The Net Foreign Asset Position (NFAP) represents the difference between a country’s external assets and external liabilities. It is a measure of the net financial claims that a country’s residents have on the rest of the world.
Net Foreign Asset Position (NFAP)=Total Foreign Assets−Total Foreign Liabilities
Total Foreign Assets: This includes the value of a country’s holdings of foreign assets, such as foreign investments, stocks, bonds, real estate, and other financial instruments.
Total Foreign Liabilities: This includes the value of a country’s obligations to foreign entities, such as foreign-owned stocks and bonds issued by the country, loans from foreign entities, and other liabilities.
Positive NFA: Indicates that a country’s external assets exceed its external liabilities. It suggests that the country is a net creditor to the rest of the world.
Negative NFA: Indicates that a country’s external liabilities exceed its external assets. It suggests that the country is a net debtor to the rest of the world.
(Currency should depreciate over time)
The balance of payments? (BoP) 6.11 was exam question in the past
The BoP has three main components:
1. Current Account (CA): records exports and imports of goods and services as well as international receipts or payments of income (if a worker in Switzerland exports money abroad)
2. Financial Account (FA): records sales of assets to foreign residents and purchases of assets located abroad from residents (foreign assets)
3. Capital Account (CAPA): debt forgiveness and entering departing migrants’ transfers
Important to know is that BoP is always equal to 0!!! If you are in a flexible exchange rate regime, where rate adjusts according to current account and capital account. In a fixed exchange rate regime this doesn’t need to hold.
Current account 2 components? 6.12 (CA)
Definition: The current account in a country’s balance of payments records the balance of trade (exports minus imports), net income from abroad (profits, dividends, and interest), and net transfers (unilateral transfers of money or goods). It provides insights into a country’s economic relationship with the rest of the world.
A1: Trade Balance (or Balance of Goods and Services): Exports minus imports of goods and services (when we go to a hair dresser for example)
✓ Merchandise Trade Balance
✓ Services Balance
A2: Income Balance:
✓ Net investment income: Difference between income receipts obtained by the Swiss on their owned foreign
assets minus the foreigners income on their Swiss assets ✓ Net international compensations for employees
A3: Net Unilateral Transfers: Gifts and migrant incomes transferred abroad
=> Current account balance = A1+A2+A3
If a country’s residents earn more income from their foreign investments than foreign residents earn from their investments in that country, the income balance will be positive. Conversely, if foreign residents earn more income from their investments within the country than the country’s residents earn from their foreign investments, the income balance will be negative.
National saving is the sum of private and public saving and together determine CA
Endowment economy? 6.15
No model for production process, Y1 and Y2 is given.
Government can receive money in 3 ways?
- Central bank by issuing money (seigniorage)
- By raising taxes
- Issuing debt (Governments can raise funds by issuing debt instruments such as government bonds. In this scenario, the government borrows money from investors or the public by selling bonds. Investors purchase these bonds with the understanding that the government will repay the borrowed amount with interest at a specified future date. Government debt issuance is a common method to finance budget deficits or fund specific projects.)
Ricardian equivalence formula? 6.18
Balance between government spending and government sources of financing. NPV of both should be equal, over wise there are imbalances, that have to be solved as some point.
NPV (Government spending) = NPV (taxes)
G1 + G2/1+r = T1 + T2/1+r
T=taxes
Intuition: A tax decrease today has no effect unless the future path of government spending decreases, because future taxes will have to be higher; private saving fully compensates public dissaving
Tax decrease today has no effect, unless the future path of government spending decreases. Because if future expenditures of government stay the same, at some point they will need to raise taxes further in order to compensate for the gap they will have in the budget.
Tax cut today is a pre announcement of a tax high in the future, if government expenditures stay the same. !!!
Crowding out effect? 6.19
The crowding out effect is an economic theory that argues that rising public sector spending drives down or even eliminates private sector spending.
To spend more, the government needs added revenue. It obtains it by raising taxes or by borrowing through the sale of Treasury securities. Higher taxes can mean reduced income and spending by individuals and businesses.
For a given level of production, if a government decides to increase spending/consumption (like increase military spending), it means there will be less resources/investment possibilities available for the private sector. Private sector will have to consume less, for a given level of production, for government to consume more.
That’s not about Ricardian equivalence!
Overlapping generation model? (he doesn’t focus to much, just wants to give as an idea of it). He doesn’t insist on knowing the formulas
Law of one price?
Identical goods sold in different locations must have the same price when prices are expressed in a common currency (assuming no arbitrage opportunities)
NPV?
Net present value (NPV) is used to calculate the current value of a future stream of payments from a company, project, or investment.
To calculate NPV, you need to estimate the timing and amount of future cash flows and pick a discount rate equal to the minimum acceptable rate of return
