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National accounting in an
open economy
Gianni Vaggi
April 2014
The components of GDP: closed and open economy
Closed economy
GDP (Y) is the sum of the following:
 Consumption (C)

Investment (I)
 Government expenditures (G)
Y=C+I+G
Open Economy
plus Net Exports (NX)
Y = C + I + G + NX
Saving, Investments and Trade
 National saving S (private and public) is the income of
the nation that is left after paying for current
consumption and government purchases:
S = Y - C - G = I + NX
S = I + NX
NX = (X – M) = Trade Balance or Balance of Goods
and services
For the moment suppose that NX is the only component
of the Current Account of the BoP
Saving, Investments and Trade
S–I=X–M
(Sp – Ip) + (T – G) = (X – M)
 Sp private savings
 Ip private investments
 T taxes
 G government expenditures
The Current Account Balance
In the BoP the Current account balance (CA) is the
sum of three items:
 Trade balance (X-M),
 Net income transfers (interest payments,
dividends, etc.;)= Net Primary Income = NPI
 Net unilateral transfers (gifts, donations,
remittances, international aid, etc.)= Net
Secondary Income = NSI
The Current Account Balance
CA = [(X-M) + NPI + NSI]
Sometimes
(NPI + NSI) are called
Net Factor Income = NFI
and NPI is called
Net Incomes
and NSI is called
Net transfers
The Financial and the Capital Account
The Financial Account , FA, has largely absorbed
what was formerly called the Capital account!!
In the BoP
CA + FA = 0
Current Account Balance + Financial Account Balance = 0
Net of Changes in reserves, R. The overall balance of payments also
includes movements of Official reserves, if private transactions do not
match exactly. Suppose: ∆R = 0.
FA = NCF = Net Capital Flows
NCF = (Inflows – Outflows)
The Current and Capital Accounts
NCF can be +/- depending on CA
If
CA = +10
then
Which means: Outflows >Inflows
Therefore:
NCF = -10
And
CA = - NCF
FA = -10
The Equality of Current Account and Net
Capital Flows
For an economy as a whole CA, and NCF must balance:
CA= [(X-M) +NPI+NSI] = FA (+/-) = NCF(+/-)
 This holds true because every transaction that affects
one side of the BoP must also affect the other side by
the same amount.
 In principle the sign of FA (+/-) depends on that of CA
Saving, Investment, and International Flows
Y = C + I +G+[(X-M) + NPI + NSI]
(S – I) = [(X-M) + NPI + NSI]= CA = FA= NCF
Saving = Domestic Investment + Net Capital Flows
S = I + NCF
Saving, Investment, and International Flows
Investments may be financed either by national saving
(S) or by foreign saving (NCF):
I = S – NCF
Remember that in general the sign of FA (+/-) and NCF
depends on the Current Account Balance,
CA,…BUT… with large international flows…
National accounting in an
indebted open economy
Gianni Vaggi
April 2014
The national accounting in an indebted open
economy
Suppose D0 = 100 to be repaid in 10 years and i = 5%,
each year:
 iD
interest payments = 5
 ΔD
principal repayment = 10
iD + ΔD = DS
Debt Service
The national accounting in an indebted open
economy
Remember:


FA = NCF = Net Capital Flows = (Inflows – Outflows)
FA = [(Inflows - Other Outflows) -ΔD] = dD/dt
•
ΔD<0
in an indebted economy ΔD is an outflow because
debt must be repaid
•
dD/dt
is the change of the debt stock during the year,
which depends also on inflows and other outflows in
the FA.
CA = [(X-M) + (NPI – iD) + NSI]
The national accounting in an indebted open
economy
CA+FA = 0

Suppose an indebted economy where there are only foreign debt related
flows:
(Inflows - Other Outflows) = 0

and no other item in NPI and NSI other than –iD
[(X-M) - iD]
- ΔD = 0
(X-M) = iD + ΔD = DS
Take the example: DS = 5 +10 = 15
The national accounting in an indebted open
economy
IF
the trade balance is 15 and exactly covers the debt service, then the
overall debt decreases by ΔD = D0 - D1 , according to the original
scheduled payments or:
-ΔD = 90 -100 = -10 = -dD/dt
IF
the trade balance is 5 and covers interests only, then ΔD = 0 and the
overall debt does not change:
dD/dt=0
IF
the trade balance is less than 5 and, then the overall debt increases:
dD/dt=>0
The Current Account Balance
Now suppose there are other financial flows in the CA
In the BoP the Current account balance (CA) is the sum of
three items:
 Trade balance (X-M)
 Net income transfers (interest payments, dividends,
etc.;)= Net Primary Income = NPI
 Net unilateral transfers (remittances, international aid,
etc.)= Net Secondary Income = NSI
The national accounting in an indebted open
economy
 Net primary income:
 Interests on foreign debt
 Dividends (on portfolio investments);
 Earnings of FDIs, profit repatriation
 Rents on land and natural resources;
 Compensation of employees (cross-border workers).
 Net secondary income:
 Personal transfers (i.e. remittances);
 Current) International cooperation,ODA
The national accounting in an indebted open
economy
Consider the following flows:
-iD
are outflows in NPI = -5
Compensation of employees are often included in remittances
NSI
includes
-remittances
-international aid , ODA
The national accounting in an indebted open
economy
Remember:
[(X-M) + NPI + NSI] = CA Current Account Balance
and CA + FA = 0
[(X-M) - iD + NSI] + (-ΔD) = 0
[(X-M) + NSI] = iD + ΔD = DS = 15
Debt sustainability - 1
 D = overall foreign debt
 Y = GDP
 gn = (dY/dt)/Y is the nominal growth rate
 Thresholds
 d(D/Y)/dt < 0
The latter: Domar 1944
Debt sustainability - 2
By total differentiation of D/Y:
d(D/Y)/dt = [ (dD/dt)*Y - (dY/dt)*D ]/ Y2
= (dD/dt)Y - [ (dY/dt)/Y ] * (D/Y)
= (1/Y) [dD/dt - gn * D ]
But
dD/dt = [inD - (X – M)]
Debt sustainability - 3
d(D/Y)/dt = inD/Y - gnD/Y - (X - M)/Y
i = (in - dp/dt) and g = (gn - dp/dt)
dp/dt inflation rate on debt
d(D/Y)/dt = (i - g)D/Y - (X - M)/Y
i, g
are the real interest rate and the GDP growth rate
Debt sustainability - 4
But there are also other financial flows:
Current Account (CA)= [(X-M) + NPI + NSI ]
NICA = [CA – iD] = Non-Interest Current Account
NICA = [CA – iD] = [(X-M) + NPI + NSI] - iD
NICA
largely depends on the trade balance, but not only.
Debt sustainability - 5
The correct sustainability formula is
d(D/Y)/dt = (i - g)D/Y - NICA/Y
Debt sustainability – 6- and
national public debt
NICA is the equivalent for foreign debt of the concept of
Primary surplus (net of interests) for domestic(public)
debt
(T – G)
= Primary surplus
[(T – G) – iD] (<0)
= overall Fiscal Deficit = FD
FD/Y
must not exceed 3%