TERM 1 : Global imbalances Flashcards by Ella Grant

TRADE BALANCE =

GOODS BALANCE + SERVICES BALANCE

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WHAT 2 THINGS COMPRISE INCOME BALANCE

NET INVESTMENT INCOME FROM K

2. NET INTERNATIONAL PAYMENTS TO EMPLOYEES

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WHAT ARE NET UNILATERAL TRANSFERS?

GIFTS FROM PRIVATE AGENTS / GOV AID FROM ROW - GIFTS TO ROW

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WHAT 3 THINGS FORMS CURRENT ACCOUNT

TRADE BALANCE
INCOME BALANCE
NET UNILATERAL TRANSFERS

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what happens to net external debt if CA<0?

Increases

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What happens to net external debt if CA>0?

decreases

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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

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What is Ireland’s ca & tb like? what does it imply?

VERY POS TB, BUT -VE CA = INCOME BALANCE MUST BE V. NEGATIVE

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How to CA across the world relate?

CA US + CA ROW = 0

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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

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NIIP < 0 means

assets < liabilities –> net debtor

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NIIP > 0 means

assets > liabilities –> net creditor

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Changes in NIIP due to (2)

current account

2. valuation changes

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HOW DOES CA AFFECT NIIP

CA<0 NIIP FALLS

CA>0 NIIP RISES

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DEFINE VALUATION CHANGES

changes in the market value of a country’s asset and liability portfolio

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When are valuation changes significant

If country has a large asset/liability portfolio

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What country has benefitted from valuation changes?

US has benefitted from +VE changes - without them external debt would be even larger.

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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

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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