TOPIC 2 - Main types of unbalances in the world economy

Question 1

What leads to growth in GDP

Answer 1

• 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

Question 2

GDP growth - Short run

Answer 2

Both growth paths are perfectly compatible

Question 3

GDP growth - Long run

Answer 3

Can only be obtained through an increase in labor productivity

Question 4

Aggregated productivity function

Answer 4

How much output is produced for a given quantity of inputs

Y = AK^α × L^β

Question 5

Define variables of Aggregated productivity function

Answer 5

Y = output
A = total factor productivity (efficiency)
K = physical capital
L = labour
α = elasticity of capital
β = elasticity of labor

Question 6

Aggregated productivity function per worker and in growth terms

Answer 6

Y/L = A (K/L)^α
=> y = Â + αK

Question 7

Growth in the Neo-classical growth model

Answer 7

Increase in labor productivity due to:
- Intensification of capital
↳ Increases in capital per worker
- Technological progress (exogenous)
↳Increase total productivity factors

Question 8

Reasons for the productivity gap EU & US

Answer 8

1. Lower market flexibility
2. Innovation and adaption
3. Human capital
4. EU single market
5. Financial sector capacity
6. Business enviorment

Question 9

Balance of payments

Answer 9

All types of economic transactions between residents and non-residents during a specific time period

Question 10

Current account

Answer 10

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

Question 11

Capital account

Answer 11

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)

Question 12

Financial account

Answer 12

Net change of assets (NCA) = Net change of liabilities (NCL)

Question 13

NCA

Answer 13

Residents’ purchases of non-residents’ assets

Question 14

NCL

Answer 14

Net change of liabilities -> Non-residents’ purchases of residents’ assets

Question 15

NCA - NCL > 0
(NCA>NCL)

Answer 15

Invest in the RW more than the RW invest in our country. Hence there is a capital outflow implying that we are creditors.

Question 16

NCA - NCL < 0
(NCA<NCL)

Answer 16

The RW invests in our country more than we invest in the RW. Hence there is a capital inflow, implying that we are debitors

Question 17

Account surplus

Answer 17

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

Question 18

Account deficit

Answer 18

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

Question 19

Account unbalances

Answer 19

Income ≠ Payments
Capital inflows ≠ Captial outflows
NCA - NCL ≠ 0

A country account is in a deficit or a surplus

Question 20

Non-residents

Answer 20

Individuals or entities that do not reside (live) in a certain country or region

Question 21

Residents

Answer 21

Individuals or entities that do reside in that country or region

Question 22

Absorption approach
Proposal 1 - Equilibrium

Answer 22

Y - A = X - M

Supply = Demand
↳ no pressure on prices
Imports = Exports
↳ no imbalance in current account

Question 23

Absorption approach
Proposal 1 - Open economy function

Answer 23

Y + M = C + I + G + X
where A = C + I + G

Question 24

Absorption approach
Proposal 1 - Variables meaning

Answer 24

Y = production
M = import
C = consumption
I = investments
G = government spending
A = internal/domestic absorption
X = exports

Question 25

Absorption approach
Proposal 1 - Current account deficit

Answer 25

Y < A ⇒ X < M
Caused by excess internal absorption compared to the disposable income

Question 26

Absorption approach
Proposal 1 - Current account surplus

Answer 26

Y > A ⇒ X > M
Caused by a lower internal absorption compared to the disposable income

Question 27

Absorption approach
Proposal 2 - Equilibrium

Answer 27

S - I = X - M

Savings = Investment
Imports = Exports
↳ no imbalance in current account

Question 28

Absorption approach
Proposal 2 - Open economy function

Answer 28

Y + M = C + I + G + X
where S = Y - C - G

Question 29

Absorption approach
Proposal 2 - Variables meaning

Answer 29

Y = output
M = imports
C = consumption
I = investment
G = government spending
X = export
S = savings (domestic)

Question 30

Absorption approach
Proposal 2 - Current account deficit

Answer 30

S < I ⇒ X < M

Due to excess internal expenditure on disposable income, hence the country must obtain financing from the RW

Question 31

Absorption approach
Proposal 2 - Current account surplus

Answer 31

S > I ⇒ X > M

Due to domestic demand being lower than disposable income, hence the country has capacity of financing the RW

Question 32

Negative sides of being in a deficit

Answer 32

The country face increasing debt, which makes them sensitive to financial crisis and debt crisis

Question 33

Negative sides of being in a surplus

Answer 33

It makes the country rely on the RW for economic growth

Question 34

What is optimal deficit or surplus

Answer 34

The optimal is to alternate between deficit and surplus → when accumulating debt they can pay it off later, visa versa.

Question 35

The objective of policymakers

Answer 35

Y - A = S - I = X - M

To obatin euqilibirum → current account balance

Question 36

How can the objective of policymakers be obtained

Answer 36

• Fiscal policy
• Monetary policy
• Exchange rate policy

Question 37

Fiscal account balance

Answer 37

Revenues = Expenditures

Question 38

Fiscal account surplus

Answer 38

Revenues > Expenditures

Question 39

Fiscal account deficit

Answer 39

Revenues < Expenditures
↳ obtain debt

Question 40

What does the fiscal revenues and expenditures consist of

Answer 40

Revenues:
- Taxes

Expenditures:
- Government spending on good/services
- Transfers
- Payments on debts

Question 41

Primary balance

Answer 41

Fiscal balance excluding net-interest payments on public debt
↳ Indicator of short-run sustainability

Question 42

To obtain fiscal balance the government can implement

Answer 42

• Automatic stabilizers
  ↳ Economic policies and programs (welfare, unemployment, etc.)
• Discretionary policies
  ↳ Government spending or taxes

Question 43

Structural balance

Answer 43

The fiscal balance a government would have with its current policies if the economy operates at its full potential
(potential GDP -> no output gap)

Question 44

Fiscal debt sustainability

Answer 44

Sustainable implies that the government debt can be paid by the government

Question 45

Rational behind negative correlation betweeen growth and debt (3)

Answer 45

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

Question 46

Burden for growth

Answer 46

When a country is in a deficit and has a debt, it must increase revenues or reduce expenditures to obtain growth.

Question 47

Issuance of debt

Answer 47

To make up for the deficit the government can borrow money by issuing debt.
↳ loans by investors to government in exchange for interest payments

Question 48

Debt function

Answer 48

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)

Question 49

Debt function variables meaning

Answer 49

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

Question 50

Debt function in GDP terms

Answer 50

b_t - b_(t-1) = dp_t + (r_t -g_t)b_t-1

Question 51

When is the debt function sustainable?

Answer 51

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

Question 52

When is the debt function not sustainable?

Answer 52

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)

Question 53

Conditions for a sustainable path - debt function

Answer 53

• 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

Question 54

Conditions for an unsustainable path - debt function

Answer 54

• If g_t < r_t and dp_t > 0

Question 55

Conditions for an unknown path - debt function

Answer 55

• 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

Question 56

Measures to reduce fiscal unbalance and public debt

Answer 56

• Ensure economic growth (g>r & dp<0)
• Unexpected inflation (g>r)
• Financial repression
• Fiscal adjustments (dp<0)
• Sell public assets
• Restructuring or non-payment