Week 1- Global Imbalances

Question 1

What is the income balance split into and what are these?

Answer 1

1. Net Investment income- Difference between income earned on US-owned assets aboard and income earned on foreign-owned US assets. This includes dividends, interest and profits.
2. Net International payments to employees- The difference between the earnings of US residents working abroad and sending money back to the US, and foreign residents working in the US and sending money away.

Question 2

What does it mean for a country if they have a negative(positive) current account?

Answer 2

• If the current account of a country is negative(Positive), all other things being equal It will mean net external debt of a country increases(Decreases)

Question 3

What is the current account of country x + the current account of the rest of the world equal to?

Answer 3

CA of country X + CA of the rest of the world = 0

Question 4

What is the Net International Investment Position (NIIP) and what does a positive/negative NIIP mean for a country?

Answer 4

• The NIIP is a stock of the differences between a country foreign assets (A) and foreign liabilities (L).
• NIIP= A-L, A= American owned foreign assets e.g a US citizen having stock in Mercedes. L- Foreign-owned American assets e.g an Italian having stocks in Tesla.
• If NIIP is negative (Positive), the country is a net external debtor (Creditor)

Question 5

What are the two reasons for NIIP changing?

Answer 5

1. Valuation changes

2. Changes in the current account

Question 6

Explain how currency changes affect the NIIP?

Answer 6

-An appreciation(depreciation) of the dollar will lead to the dollar becoming more valuable, as a result US assets will increase in value which will lead to to to an increase in L and a fall in NIIP

Question 7

What has happened to the magnitude of valuation changes recently?

Answer 7

• Up until about 2003 valuation changes were only about +-3%, but since then they have increased dramatically and now are +-15% of GDP.

Question 8

What is the negative NIIP-Positive NII Paradox?

Answer 8

There are 2 observations for the US:

1. The US has a +ve net income balance driven by a positive net investment income ( US receives more capital from the R.O.W then it gives out)
2. The US has a large -ve NIIP this mean the US is a net external debtor to the R.O.W.

This paradox explain why the US receives income from the rest of the world if its in so much external debt.

Question 9

What are the two causes of the paradox?

Answer 9

1. Return Differentials

2. Dark Matter

Question 10

Explain the dark matter part of the paradox

Answer 10

• Think of NIIP as an asset, the value of this asset is underestimated because when an American company such as McDonald’s opens a restaurant in Russia only the land and machinery it purchases contributes towards the value of the asset.
• NIIP fails to recognise the power of intangible assets such as Brand i.e McDonald’s, the fact that it is a brand will mean it adds extra value and increases the stock price, but the increase in stock price is not considered and therefore the value of the NIIP is underestimated.

Question 11

Explain the return differentials part of the paradox

Answer 11

• NIIP= A-L, Return differentials argues that A is made up of risky high return assets while liabilities are made up fo safer low return assets.
• It is estimated that the Assets compared to the Liabilities increase overall by 1.024% quicker than liabilities
• With overall asset and liabilities positions doubling over the past decade it makes sense to why this is a cause of the paradox.

Question 12

What does the financial account keep a record of, and what does it measure?

Answer 12

• The financial account keeps records of sales and purchases of assets.
• Therefore the financial account measures the changes in a countries net foreign asset position. Sales of assets to foreigners are given with a positive sign, and purchases of assets located abroad a negative sign.

Question 13

Give an example of a double-entry bookkeeping

Answer 13

Suppose an Italian citizen visits the US and stays at a hotel, and pays $400 with his Italian credit card. In this case the US is exporting a service (hotel), so the current account increases by $400, at the same time you have $ coming into the US which decreases the U.S financial account by $400.

Question 14

What is the effect on the Balance of payments of a US resident purchasing from Fiat (an Italian company) and paying with $.

Answer 14

The financial account receives a positive entry (the ‘sale’ of $ to Italy), and a negative entry (the purchase of shares from Italy)

Question 15

What is the trade balance equal to?

Answer 15

Trade balance = Exports - Imports (Goods and services balance of each)

Question 16

What are Net unilateral transfers equal to?

Answer 16

Net unilateral transfers = Private remitances + Govt transfers

Question 17

What is the relationship between the current account balance and the financial account balance?

Answer 17

Current account balance = -Financial account balance

Question 18

What is the NIIP equal to and what do they measure?

Answer 18

NIIP = A-L
A-Domestically owned foreign assets
L-Foreign owned domestic assets

Question 19

What is the change in NIIP equal to?

Answer 19

Change in NIIP = CA + Valuation changes, where valuation changes are changes in the market value of the countries foreign asset and liability positions due to currency appreciations/depreciations.