Lecture 10: The Balance of Payments Flashcards
Private income formula
= (Y - T) - C
National income formula
= C + I + G + (X - M)
National savings formula
= S + (T - G) +I
= X - M (trade balance)
Current account balance
= Trade balance + net foreign income balance
* Trade balance - G/S’s
* NFI balance = capital income, labour income, taxes and transfers etc.
How is a CA deficit financed?
Through borrowing and/or selling assets to foreigners which is recorded in the capital account this is done through:
1. Foreign Direct Investment
2. Portfolio investment (purchases of securities etc.)
3. Government transactions
Key BoP identity
Current Account + Capital Account = 0
Net Foreign Liabilities
= Gross foreign liabilities (foreign claims on domestic economy) - Gross foreign assets (domestic claims on foreign economy)
Are persistent current account deficits a problem?
- Pessimistic: Current Account Deficit is a result of low savings, meaning debt burden will grow and consumption will have to fall in the future (living beyond our means)
- Optimistic: Capital Account Surplus because our economy is a good place to invest
as when there is a current account deficit there is a capital account surplus
the main concern is that of a sudden withdrawal of international lending
Determinants of net capital inflows
- Real return on domestic assets, r - when this is high it makes domestic assets relatively more attractive to foreign investors which increases capital inflows
- Real return on foreign assets, r* - when high is makes foreign assets relatively more attractive which reduces inflows and increases outflows
- Risk premia, both home and abroad -if risk is high investors need a risk premium as ‘compensation’
Two types of risk
- Exchange rate risk - return on investmant in foreign foreign currency is impacted
- Sovereign risk - international gov may have different laws - meaning investors in a foreign market may have lower rights
