TERM 1 : Global imbalances Flashcards
TRADE BALANCE =
GOODS BALANCE + SERVICES BALANCE
WHAT 2 THINGS COMPRISE INCOME BALANCE
- NET INVESTMENT INCOME FROM K
2. NET INTERNATIONAL PAYMENTS TO EMPLOYEES
WHAT ARE NET UNILATERAL TRANSFERS?
GIFTS FROM PRIVATE AGENTS / GOV AID FROM ROW - GIFTS TO ROW
WHAT 3 THINGS FORMS CURRENT ACCOUNT
- TRADE BALANCE
- INCOME BALANCE
- NET UNILATERAL TRANSFERS
what happens to net external debt if CA<0?
Increases
What happens to net external debt if CA>0?
decreases
how do CA and TB relate?
CA & TB move in tandem if look at country cross-sectional data at one point in time, but some exceptions
What is Ireland’s ca & tb like? what does it imply?
VERY POS TB, BUT -VE CA = INCOME BALANCE MUST BE V. NEGATIVE
How to CA across the world relate?
CA US + CA ROW = 0
WHAT IS THE NIIP? FORMULA?
difference between a country’s foreign owned assets & it’s foreign liabilities.
NIIP = US owned foreign assets - foreign owned US assets
NIIP < 0 means
assets < liabilities –> net debtor
NIIP > 0 means
assets > liabilities –> net creditor
Changes in NIIP due to (2)
- current account
2. valuation changes
HOW DOES CA AFFECT NIIP
CA<0 NIIP FALLS
CA>0 NIIP RISES
DEFINE VALUATION CHANGES
changes in the market value of a country’s asset and liability portfolio
When are valuation changes significant
If country has a large asset/liability portfolio
What country has benefitted from valuation changes?
US has benefitted from +VE changes - without them external debt would be even larger.
How to reduce net external debt i.e. increase NIIP (2)
- Dollar depreciation - value of liabilities in $ falls relative to value of assets which are in foreign currency
- Stock market gains
What is the NIIP NII paradox?
US has positive NIIP
But negative NII
What is NII?
Net investment income
income receipts on US owned foreign assets - income payments on foreign owned US assets
How do NIIP and NII relate?
NII = the return on TNIIP
2 explanations for NIIP NII paradox
- Dark matter - true NIIP ≠ NIIP
2. Return differential - rA ≠ rL
Why is there a return differential for US NIIP?
US owned foreign assets = risky, high return
Foreign owned US assets = safer, lower return
rA > rL –> NII > 0
A country CANNOT run a perpetual TB deficit if
NIIP < 0 i.e. net debtor
Need a TB surplus at some point to service its debt
A country CAN run a perpetual TB deficit if
NIIP > 0 i.e. net creditor
Can run TB deficits and finance by the interest from net investments abroad
NIIP end of period 1 for TB deficit analysis
B1* = (1+r)B0* + TB1
NIIP end of period 2 for TB deficit analysis
B2* = (1+r)B1* + TB2
Condition on B2* and why?
B2*=0
Cannot hold any debt or assets at end of period 2 as everyone dies so no one willing to lend.
Equation for can run TB deficit & explain
(1+r)B0* = -TB1 - TB2/(1+r)
net foreign asset position including interest = present discounted value of all future trade deficits
- If B0<0 net debtor, need TB>0 at some point for equation to hold
- If B0>0 net creditor, TB1 and TB2 < 0 and equation holds
Can run a perpetual CA deficit? what condition
Bo*=-CA1 - CA2
- If B0*>0, Ca1<0 and ca2<0
Savings, investment, CA identity. explain.
CA1 = S1 - I1
If savings > what is needed to finance domestic investment, rest goes abroad to purchase foreign assets therefore CA +VE
AS-AD formula
Q1 + IM1 = C1 + G1 + I1 + X1
CA formula
CA1 = rB0* + TB1
Again how does CA relate to NIIP if valuation changes =0?
CA = change in the NIIP
- CA = yearly change
- NIIP = cumulative position across all years
National savings formula
S1 = Y - C1 - G1
Initial NIIP formula in infinite horizon economy
B0=BT/(1+r)^T - TB1/(1+r) - TB2/(1+r)^2-…-TBT/(1+r)^T
What is the no ponzi game constraint infinite horizon economy?
Lim T–> infinity BT*/(1+r)^T >=0
What is the transversatility/optimality condition infinite horizon economy?
Lim T–> infinity BT*/(1+r)^T <=0
What does this mean for the initial NIIP formula infinite horizon economy?
BT*/(1+r)^T = 0
So B0* = -TB1/(1+r) - TB2/(1+r)^2 -…-TBT/(1+r)^T
Can a country run a perpetual TB deficit in infinite horizon economy?
If B0*<0 net debtor, need TB>0 at some point so NO!
Law of motion for Bt*
Bt* = (1+r)Bt-1* + TBt
Formula for TBt given that we assume each period a country runs TB surpluses and pays a fraction of its IR obligations. Subsequent formula for Bt*
TBt= -alpha rBt-1* Bt* = (1 + r - alpha r)Bt-1*
Law of motion for CAt
CAt = rBt-1* + TBt
Formula for CAt in infinite horizon pay fraction of interest setting
CAt = r(1-alpha)Bt-1* (<0)
Does it satisfy transversality & no-ponzi condition infinite horizon CA
Bt/(1+r)^t = ((1 + r - alpha.r)/(1+r))^t B0
As t–> infinity, converges to zero since denom>numer
So YES!
Evolution of TBt infinite horizon in terms of alpha, r and B0* & explain
TBt= -alpha.r(1 + r(1 - alpha))^t-1 B0*
To sustain TB surpluses growing at rate r(1 - alpha)
Need GDP growth >= r(1 - alpha)
Since if exporting everything & IM=0, need production to rise for TB to grow unboundedly.
If so, this repayment plan works even if B0*<0
