National Income Accounting

Question 1

Net Investment Received from Foreigners

Answer 1

Investment income received - Investment income paid.

Investment income received:
Shares being earned by domestic bodies who invested in foreign companies
(money moving into the country)

Investment income paid:
Liquidating shares to pay international bodies (money moving out of the country)

Question 2

Government Budget Constraint

Answer 2

The government must borrow when expenses exceed income/revenue, incurring a primary deficit. E > I

Question 3

Primary Deficit (Debt)

Answer 3

Primary Deficit: Government Spending - Taxes (expenditure - revenue).

A government has a primary deficit if it spends more on public goods and services than it collects in taxes. This means the government must borrow money to pay for the everyday public goods and services it provides for citizens.

Deficits correspond to debt. Most debt holders hold nominal debt.

Question 4

Real Value of Debt

Answer 4

When prices rise, the real value of debt falls.

The process of growing prices is inflation.

Question 5

Predicted Growth of Debt

Answer 5

For Countries with current debt over 100%, paying all revenue owed to debt holders will not be sufficient for paying off the entire debt. Countries such as Italy or Japan will still owe debt.

So how do these economies operate? Japan has an incredible reputation with investors, so long as Japan is able to pay its debt to investors, investors will keep investing and the economy will be sustained.

Moreover, investors know that the predicted growth in debt reflects governments’ response to the global pandemic rather than anything systematically wrong with the country. Investors are willing to “weather the storm.”

Question 6

Running a Deficit

Answer 6

When governments operate within a deficit, their expenditures are larger than their taxes.

If there is a surplus, such as from years 1998 - 2008, then that means taxes are larger than expenditures.

Question 7

Running Down Debt

Answer 7

Governments sometimes opt to continue borrowing (run-up debt), and other times, governments try to pay back borrowing (run-down debt).

Governments will want to run-down debt in anticipation of shocks in the economy. In other words, they anticipate that they will have to take on borrowing (need money) at a future date, so by running down their debt, borrowing will be cheaper when the time comes.

Question 8

Government Sources of Revenue

Answer 8

Personal income taxes represent the government’s larget source of revenue. A small increase in personal income tax can generate large volumes of revenue.

Question 9

Optimal debt to GDP ratio

Answer 9

It is some positive number (say 20%), but not 50%.

Suppose the government eliminates the deficit. What should the government do with its surplus?

1. Increase spending,
2. Reduce taxes,
3. Pay off the debt.

There is less incentive to pay off debt for politicians. Often, they opt to increase government spending and/or reduce taxes.

Question 10

Debt Management

Answer 10

Debt repayment is important. If interest rates rise, large debt generates large interest payments.

If the deficit disappears, growth in debt stops.

As GDP rises, debt to GDP ratio falls.

Question 11

Savings of the Rest of the World

Answer 11

If Canada has higher exports, there is lower savings of the rest of the world.

If Canada has higher imports, there is higher savings of the rest of the world (the rest of the world is making more money off of Canada, than Canada is making off of the world).

Question 12

Trade

Answer 12

Gains from trade arise because of differing opportunity costs

Question 13

Comparative Advantage

Answer 13

A country has a comparative advantage in producing a good over another country if the opportunity cost of producing that good is lower

Question 14

Absolute Advantage

Answer 14

A country has absolute advantage if they can produce the same quantity of goods with fewer resources

Question 15

Drawbacks of Free Trade

Answer 15

The main potential drawback of Free-trade is an increase in inequality. By moving economic activity to labour-abundant economies, the return to low-skill workers falls in the advanced economies while the return to high-skill workers increases.

Firms that benefit from trade face the risks of societal backlash.

In the opinion of Friedman, later quantified by Autor et al.

Example: Rising imports from China led to about 25% loss of US manufacturing jobs since 1990

Question 16

Trade Deficit

Answer 16

An excess of imports over exports.

There is a trade deficit if S − I and NX (Net exports) are negative.

When a government experiences a trade deficit, there will be a capital inflow.

Question 17

Trade surplus

Answer 17

An excess of exports over imports.

There is a trade surplus if S − I and NX (net exports) are positive.

Question 18

Trade Balance (Another name for Net Exports)

Answer 18

The receipts from exports minus the payments for imports.

Tells us how our trade in goods and services departs from the benchmark of equal imports and exports.

Question 19

Domestic Investment

Answer 19

National Income Accounting:
Y = C + I + G + (EXPORTS - IMPORTS)

REARRANGE:

Domestic Investment (I) = Private Savings + Public Savings + Foreign Savings

Domestic Investment (I) =
(Output (Y) - Consumption (C) - Taxes (T) +
(Taxes (revenue)- Government Spending (expenditure)) +

(Imports - Exports)

Question 20

Domestic Savings (Sd)

Answer 20

Output - Consumption - Taxes + ( Taxes - Government spending)

(Y - C - T) + ( T - G)

Question 21

Trade Balance Formula

Answer 21

Trade Balance (X)
= Exports - Imports
= Savings - Investments

X = EX - IM = S - I

S - I = (Net Capital Outflow)

Question 22

Positive Trade Balance

Answer 22

A positive trade balance indicates capital outflow (savings > investments).

Your trade balance is positive if you export more than you import.

And if you export more than you import, your savings are larger than your investments.

Extra savings can be used to finance imports from the rest of the world or finance more exports to the country..

Question 23

Can rising imports or a trade deficit lead to “slower economic growth”?

Answer 23

No. A trade deficit (having more imports) does not lower GDP. It will never subtract from GDP because it is added to Consumption (neutralized).

If the government runs a trade deficit, it simply indicates that they are saving less than they are investing, which implies they are taking on more debt.

Question 24

Business Leverage

Answer 24

The amount of debt a company has in its mix of debt and equity(its capital structure).

The more leverage a business possesses, the more they can invest in new projects and develop/expand product lines.

Question 25

Long-Run Trade Balancing

Answer 25

Trade must be balanced in the long run. A company cannot borrow forever in the net present value sense.

Question 26

When can trade deficits be beneficial for the economy?

Answer 26

Strong opportunities for investment in a growing economy.

Intertemporal trade to smooth a “negative” shock…. e.g. sudden need to import masks

Question 27

When can trade deficits be problematic for the economy?

Answer 27

Competitiveness issues: import what is too expensive to produce locally

Low savings

Question 28

Capital Flows

Answer 28

Capital flows refer to the movement of money for the purpose of investment, trade, or business operations.

Question 29

Global Capital Markets

Answer 29

In the absence of global capital markets, the only way to finance domestic investment is have domestic savings!

Developing countries with tremendous investment opportunities: cannot realistically ask developing countries to increase domestic savings.

Similarly, productive investment opportunities in the US are being exploited (financed) by both US and global investors.

Of course, global capital flows come at some risk, e.g. herding behaviour.

Question 30

Foreign Direct Investment (FDI)

Answer 30

A category of investment that reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor.

Question 31

FDI Relationships

Answer 31

The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the enterprise.

The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is evidence of such a relationship.

Question 32

Outward FDI

Answer 32

An outward direct investment (ODI) is a business strategy in which a domestic firm expands its operations to a foreign country.

Question 33

Inward FDI

Answer 33

An inward investment involves an external or foreign entity either investing in or purchasing the goods of a local economy. It is foreign money that comes into the domestic economy.

Question 34

FDI Ratio

Answer 34

Outward FDI exports to the world.
Inward FDI imports to the world

If the FDI Ratio is lower than one, that indicates that Canada receives more FDI than it exports.

Question 35

Outward-to-Inward Ratio Increases

Answer 35

If the outward-to-inward ratio increases, that signals that outward FDI is growing faster than inward FDI.

Canada started to export FDI to the world (related to oil businesses) in the 70s-90s.

Question 36

Portfolio Investments

Answer 36

A portfolio investment is ownership of a stock, bond, or other financial assets with the expectation that it will earn a return or grow in value over time, or both.

Question 37

GDP/GNP Ratio (Portfolio Investments)

Answer 37

A ratio below 1 indicates that GDP is higher than GNP. This suggests that money is still flowing into the country as portfolio investments, given that value produced domestically is greater than the value produced by Canadian owned factories.

Question 38

Personal Assessment:

1. What is the national income identity and how it relates to savings by different agents in the economy?
2. How does the government finances his debt? How can it pay for it?
3. Recompute exercise in slide 20 for a target of 10%.
4. What is the role of trade?
5. Why are savings in an economy related to their trade deficit?

Answer 38

1. The national income identity Y = C + I + G + X

Investment=Savings, so Savings=Y-C-G-X and savings can come from the private sector, the government or the rest of the world.

2. Government finances debt with taxes or new debt.
3. T=ln(5)*1/0.02=80.5 years!
4. Trade allows consumers and firms in different countries to benefit from technologies, goods and services in other economies. It also allows countries to specialize in the technologies where they have the highest comparative advantage. Because the trade deficit is the counterpart to the difference between local investment and savings, it holds information about the ability of the economy to finance investment with savings from abroad.
5. S=I(Savings = Investment)