TOPIC 2 - Main types of unbalances in the world economy Flashcards
What leads to growth in GDP
- Increase the percentage of the population that performs productive activities (or per capita employment rate)
- Increase in labor productivity
- Or an increase in both at the same time
GDP growth - Short run
Both growth paths are perfectly compatible
GDP growth - Long run
Can only be obtained through an increase in labor productivity
Aggregated productivity function
How much output is produced for a given quantity of inputs
Y = AK^α × L^β
Define variables of Aggregated productivity function
Y = output
A = total factor productivity (efficiency)
K = physical capital
L = labour
α = elasticity of capital
β = elasticity of labor
Aggregated productivity function per worker and in growth terms
Y/L = A (K/L)^α
=> y = Â + αK
Growth in the Neo-classical growth model
Increase in labor productivity due to:
- Intensification of capital
↳ Increases in capital per worker
- Technological progress (exogenous)
↳Increase total productivity factors
Reasons for the productivity gap EU & US
- Lower market flexibility
- Innovation and adaption
- Human capital
- EU single market
- Financial sector capacity
- Business enviorment
Balance of payments
All types of economic transactions between residents and non-residents during a specific time period
Current account
Exports = Imports (goods/services)
Income received by residents for labor and capital used by non-residents = Payment made by residents for using labor and capital of non-residents
Current transfers from non-residents to residents = Current transfers from residents to non-residents
Capital account
Capital transfers and assets moving in and out of the country or region are equal.
Capital outflows = Capital inflows
(Capital transfers from non-residents to residents & income from non-produced & non-financial assets = Capital transfers from residents to non-residents & and payments for non-produced & non-financial assets)
Financial account
Net change of assets (NCA) = Net change of liabilities (NCL)
NCA
Residents’ purchases of non-residents’ assets
NCL
Net change of liabilities -> Non-residents’ purchases of residents’ assets
NCA - NCL > 0
(NCA>NCL)
Invest in the RW more than the RW invest in our country. Hence there is a capital outflow implying that we are creditors.
NCA - NCL < 0
(NCA<NCL)
The RW invests in our country more than we invest in the RW. Hence there is a capital inflow, implying that we are debitors
Account surplus
Income > Payments
Capital inflows < Captial outflows
NCA - NCL > 0 (NCA>NCL)
Implies that has external financing capacity for the RW (we are creditors), thus we finance the RW
Account deficit
Income < Payments
Capital inflows > Captial outflows
NCA - NCL < 0
Implies that we need the RW to finance us (we are debitors), hence we go into debt to the RW
Account unbalances
Income ≠ Payments
Capital inflows ≠ Captial outflows
NCA - NCL ≠ 0
A country account is in a deficit or a surplus
Non-residents
Individuals or entities that do not reside (live) in a certain country or region
Residents
Individuals or entities that do reside in that country or region
Absorption approach
Proposal 1 - Equilibrium
Y - A = X - M
Supply = Demand
↳ no pressure on prices
Imports = Exports
↳ no imbalance in current account
Absorption approach
Proposal 1 - Open economy function
Y + M = C + I + G + X
where A = C + I + G
Absorption approach
Proposal 1 - Variables meaning
Y = production
M = import
C = consumption
I = investments
G = government spending
A = internal/domestic absorption
X = exports
Absorption approach
Proposal 1 - Current account deficit
Y < A ⇒ X < M
Caused by excess internal absorption compared to the disposable income
Absorption approach
Proposal 1 - Current account surplus
Y > A ⇒ X > M
Caused by a lower internal absorption compared to the disposable income
Absorption approach
Proposal 2 - Equilibrium
S - I = X - M
Savings = Investment
Imports = Exports
↳ no imbalance in current account
Absorption approach
Proposal 2 - Open economy function
Y + M = C + I + G + X
where S = Y - C - G
Absorption approach
Proposal 2 - Variables meaning
Y = output
M = imports
C = consumption
I = investment
G = government spending
X = export
S = savings (domestic)
Absorption approach
Proposal 2 - Current account deficit
S < I ⇒ X < M
Due to excess internal expenditure on disposable income, hence the country must obtain financing from the RW
Absorption approach
Proposal 2 - Current account surplus
S > I ⇒ X > M
Due to domestic demand being lower than disposable income, hence the country has capacity of financing the RW
Negative sides of being in a deficit
The country face increasing debt, which makes them sensitive to financial crisis and debt crisis
Negative sides of being in a surplus
It makes the country rely on the RW for economic growth
What is optimal deficit or surplus
The optimal is to alternate between deficit and surplus → when accumulating debt they can pay it off later, visa versa.
The objective of policymakers
Y - A = S - I = X - M
To obatin euqilibirum → current account balance
How can the objective of policymakers be obtained
- Fiscal policy
- Monetary policy
- Exchange rate policy
Fiscal account balance
Revenues = Expenditures
Fiscal account surplus
Revenues > Expenditures
Fiscal account deficit
Revenues < Expenditures
↳ obtain debt
What does the fiscal revenues and expenditures consist of
Revenues:
- Taxes
Expenditures:
- Government spending on good/services
- Transfers
- Payments on debts
Primary balance
Fiscal balance excluding net-interest payments on public debt
↳ Indicator of short-run sustainability
To obtain fiscal balance the government can implement
- Automatic stabilizers
↳ Economic policies and programs (welfare, unemployment, etc.) - Discretionary policies
↳ Government spending or taxes
Structural balance
The fiscal balance a government would have with its current policies if the economy operates at its full potential
(potential GDP -> no output gap)
Fiscal debt sustainability
Sustainable implies that the government debt can be paid by the government
Rational behind negative correlation betweeen growth and debt (3)
An increase in debt:
- Increse the interest payments
↳implies a cut in expenses and/or increase in taxes
- A drop in investments
- Loss of margin to practice countercyclical policies
Burden for growth
When a country is in a deficit and has a debt, it must increase revenues or reduce expenditures to obtain growth.
Issuance of debt
To make up for the deficit the government can borrow money by issuing debt.
↳ loans by investors to government in exchange for interest payments
Debt function
Differentiate the deficit from current and past fiscal policy
B_t = D_t + B_(t-1)
⇒ B_t = DP_t + (1+r_t) B_(t-1)
Debt function variables meaning
B_t = total debt period t
D_t = public deficit t
DP_t = primary deficit in t
B_(t-1) = debt generated in period t-1
r_t = nominal interest rate (r= π + ρ)
(1+r_t) B_(t-1) = interest payment on public debt from previous period
g = GDP
Debt function in GDP terms
b_t - b_(t-1) = dp_t + (r_t -g_t)b_t-1
When is the debt function sustainable?
Debt is sustainable if the debt in t is less /equal to the level of debt in t-1
b_t - b_(t-1) ≤ 0
⇒ dp_t + (r_t - g-t) b_(t-1) ≤ 0
When is the debt function not sustainable?
Debt is sustainable if the debt in t is higher than the level of debt in t-1
b_t - b_(t-1) > 0
⇒ - dp_t ≥ (r_t - g-t) b_(t-1)
Conditions for a sustainable path - debt function
- If (r_t - g_t) b_t-1 = 0 then dp_t ≤ 0
- If g_t ≥ r_t then dp_t ≤ 0
↳ △GDP + π ≥ ρ + πê
Conditions for an unsustainable path - debt function
- If g_t < r_t and dp_t > 0
Conditions for an unknown path - debt function
- g_t ≥ r_t but dp_t > 0
- dp_t ≤ 0 but g_t < r_t
To determine if this path is sustainable or not we need to do calculations
Measures to reduce fiscal unbalance and public debt
- Ensure economic growth (g>r & dp<0)
- Unexpected inflation (g>r)
- Financial repression
- Fiscal adjustments (dp<0)
- Sell public assets
- Restructuring or non-payment
