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Macroeconomic Accounting Selcuk Caner Bilkent University 5/23/2017 1 Outline Flow of Funds Current Account Capital Account Macroeconomic Consistency Framework 5/23/2017 2 Flow of Funds Consider an economy consisting of – The government, – Private sector, – External sector – Monetary system (central bank and commercial banks) 5/23/2017 3 Income = Wages and Salaries + Operating surplus + Income of self-employed + imputed value of household production + property income (interest, dividend, royalties, rent, patents, rights) Value of services by financial institutions included in GDP. – Service charges – Difference between income received on loans and interest/claims paid on deposits. 5/23/2017 4 Basic Relationships in an Economy? Production and income (+ transfers) Income and Expenditures Savings and Asset Acquisition Income and transfers = Used for financing expenditures = S + Exp. 5/23/2017 5 Current Accounts Current domestic product (expenditures at market prices) = Ymp = Cg + Cp + X – Z + I Imports Ymp + Z = (T – Sb)+ OSg + (W+p) + Z + I (Taxes – Subsidies) 5/23/2017 Operating Surplus of Gov. Enterprises Operating Surplus of Other Enterprises 6 Current Accounts Total Government Current Use (Expenditure) – CEXPg = Cg + NTRCgp + INTg + INTe + Sg Total Government Income – Yg = (T – Sb)+ OSg + Td + NTReg Household Expenditure (Private sector) – CEXPp = Cp +Td + INTpe + S Household Income (Private sector) – Yp = W + p + ps + NTRgp + INTgp + NTRep + NFPep 5/23/2017 Property income included in operating surplus of producing units 7 Current Accounts Current Account Balance – Total Current Foreign Exchange Receipts = X + NTReg + NTRep + NFPep + CA (or Se) – Total Sources of Income Accruing to Foreign Residents = INTge + INTpe + Z => X + NTReg + NTRep + NFPep + CA = INTge + INTpe + Z 5/23/2017 8 Capital Accounts Financing of the acquisition of assets by the government, private sector and the external sector through the monetary system – Government expenditure on asset acquisition = Ig • Gross fixed assets • Inventories and working capital • Acquisition of financial and foreign assets – Financing by government (Government savings + D in gov. borrowing) = Sg + DDCg + DNPBg + DNFBg New borrowing from monetary system 5/23/2017 New direct borrowing from private sector Foreign borrowing 9 Capital Accounts Monetary system – Acquisition of new liabilities = DM – (I.e., new currency issues, demand deposits, other liabilities such as T-bills) – Acquired assets DM = + DDCg + DDCp + DR Private sector – Change in assets of private sector DASp = Ip + DNPBg + DM 5/23/2017 Net lending to government 10 • Financing private sector assets (private sector savings + D in borrowing) = Sp + DDCp + DNFBp Borrowing from monetary system Borrowing from foreigners External Sector • Change in foreign borrowing DNFB = DNPBg + DNPBp • Savings of Foreign Residents (CA) and Net Accumulation of Foreign Assets • = CA + DR => DNFB = CA+ DR 5/23/2017 S+CA = I 11 Macroeconomic Consistency Framework Government Savings – Sg + DDCg + DNPBg + DNFBg = Ig Private Sector Savings Ip + DNPBg + DM = Sp + DDCp + DNFBp • Foreign Savings • CA + DR = DNPBg + DNPBp • Or • CA = DNPBg + DNPBp - DR 5/23/2017 Foreign borrowing by: gov. departments, monetary system, directly by private sector So difficult to keep track 12 GDP Ymp = Cg + Cp + X – Z + Ip + Ig Ymp – (C + I) = (X – Z) (Ymp – C) - I = (X – Z) Savings gap Trade gap CA = I – S and CA = I - (Ymp – C) 5/23/2017 13 Government Budget Constraint Yg = (T – Sb)+ OSg + Td + NTReg Rewrite as Yg = CEXPg + Ig – (DDCg + DNPBg + DNFBg ) So, Budget Deficit is Financed as Yg - CEXPg - Ig = – (DDCg + DNPBg + DNFBg ) Budget deficit So, IMF programs have 5/23/2017 restrictions on credit to fight inflation If this is limited then crowding out can occur 14 Private Sector Budget Constraint – Yp = W + p + ps + NTRgp + INTgp + NTRep + NFPep = CEXPp + Sp – Since Sp = Ip + DNPBg + DM - DDCp - DNFBp – Substitute in the above expression for Sp and rearrange yielding Yp = CEXPp + Ip + DNPBg + DM – (DDCp + DNFBp) Yp + (DDCp + DNFBp) - CEXPp = Ip + DNPBg + DM Private sector financing of asset acquisition 5/23/2017 Private sector asset acquisition 15 External Sector Budget Constraint X + NTReg + NTRep + NFPep + CA = INTge + INTpe + Z Substitute DNPBg + DNPBp - DR for CA (INTge + INTpe + Z) – (X + NTReg + NTRep + NFPep) = DNPBg + DNPBp - DR Asset acquisition by foreigners A fall in this means capital flight 5/23/2017 There is an opportunity cost to holding high reserves in terms of foregone consumption and investment 16 Assets and Liabilities of the Monetary System DM = DDCg + DDCp + DR If DM = 0, then, DR = -DDC That is an increase in credits are offset by a reduction in reserves. 5/23/2017 17 Absorption and Domestic Credit Ymp – A = X – Z = (DNFB – INT) - DR But since DR = DDCg + DDCp - DM We can rewrite as (Ymp + DNFB – INT) – A = DDCg + DDCp 5/23/2017 18 Current Government Deficit CA S + CA = I Sg + (Sp – I) = - (NFBp + NFBg – DR) Current external balance (right hand side) can only improve if government savings rise => So, is the reason for primary surplus 5/23/2017 19