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Current Account
1
Issues and Applications
• Global capital markets and the current account
• Debt crisis in developing countries
• Sovereign risk
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Balance of Payments Accounting:
The Current Account (CA)
• The current account (CA): measures a country’s
trade in currently produced goods and services
• A negative CA implies that a country is
importing more than it is exporting
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The Current Account around the World
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The Capital and Financial Account (KFA)
• The capital and financial account (KFA) measures a
country’s trade in financial assets
• Note that selling assets (e.g. bonds) is equivalent to
borrowing and leads to inflow of capital, that is the rest
of the world is lending money to us
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The Link Between CA and KFA
• The current account and the capital financial account
sum to zero
CA+KFA=0
• This equation is an Accounting Identity!
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Savings, Investment and the Current Account
• We know from the Introduction that
NX + NFP = CA = S – I
• Focusing on S – I is equivalent to looking at the CA or
the KFA
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U.S. Current Account
Source: US Bureau of Economic Analysis
www.bea.gov
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Savings, Investment, and CA
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U.S. Net International Debt
$2.5 trillion is approx. 25% of GDP
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Sources of Funds for US borrowing
What finances US current account deficits:
– Sale of US treasury debt
– Sale of Corporate debt
– Equities
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Global Capital Markets
• Financial markets in New York, London, Frankfurt, Tokyo
• Each country has savings
• All these savings enter global financial markets
• Each country has needs for investment in new plant and
equipment
• The job of the global financial markets is to efficiently
allocate the global pool of savings to investment
opportunities in different countries
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Determinants of Savings
• Aggregate savings is income minus
consumption:
s=y–c–g
• Aggregate savings is the sum of private
savings and government savings
– Govt. Savings are Net Tax Revenue-Govt. expenditure
s = sp + sg
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Determinants of National Saving
Fig. 1
r
r
s1
S
•
Fig. 3
s1
s2
•
•
S
s2
s1
S
r
Fig. 2
An increase in the real interest rate causes
desired national saving to rise, as the reward
to savings rises, see Fig 1.
An increase in G causes desired aggregate
savings to fall, as overall consumption rises,
Fig. 2.
An temporary increase in Y causes desired
national saving to rise, as households spread
the rise in income over current and future
consumption, Fig. 3.
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Determination of the Current Account
Variables subscripted by w refer to global variables,
and those subscripted by arg refer to Argentina.
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Current Account
• The global capital markets determine the world
real interest rate
• A country’s savings and investment determines its
current account
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Good Prospects and the Current Account
Does a country that experiences a permanent rise in TFP and thereby produces more goods
and services respond by on net importing or exporting more goods and services?
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Growth and the Current Account
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Recessions and the Current Account
Current account deficit falls during recessions and rises during booms
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Recent U.S. Current Account
Current account deficit continues to get larger
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Economic Growth
Average Growth of GNP per Capita, 1965-90
Latin America and the Caribbean
OECD Economies
Sub-Saharan Africa
Middle East and Mediterranean
South Asia
HPAEs
0
1
2
3
4
5
6
GNP pe r capita growth rate (pe rce nt)
OECD refers to Organization of Economic Cooperation and Development. This includes
the world’s 24 richest economies.
High performance Asian economies (HPAE) are: Singapore, Hong Kong, Thailand,
Indonesia, Taiwan, Malaysia, Korea.
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Education in HPAE
Hong Kong
1966
1991
Singapore
1966
South Korea
1990
1966
1990
Taiwan
1966
1990
None
19.2
5.6
55.1
-
31.1
6.4
17.0
4.5
Primary
53.6
22.9
28.2
33.7
42.2
18.5
57.2
28.0
Secondary
27.2
71.4
15.8
66.3
26.5
75.0
25.8
67.6
Educational Attainment of the Working Population (Percent)
Education is the engine of TFP growth
Primary is till eighth grade and secondary is high school
Source: Alwyn Young, ‘The Tyrrany of Numbers: Confronting the Statistical Realities of
the East Asian Growth Experience’, Quarterly Journal of Economics, 1995
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High Investment
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Current Account in HPAE
Current Account as % of GDP
14
9
1975
4
Thailand
Malaysia
Singapore
-11
Korea
-6
1994
Indonesia
-1
1985
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CA surplus in China, Germany, and Euro.
Why?
High savings rate leads to a current account surplus
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Sovereign Debt, External Debt, and Risk
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Sovereign debt is debt issued by a government (also public debt)
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Risk And Sovereign Debt
• Countries cannot be taken to court if they default on their borrowings
• This leads to sovereign risk which is reflected in the cost of borrowing
• Sovereign risk depends on the credibility of not defaulting on the debt
• Sovereign risk ratings are almost entirely determined by the
macroeconomics of the country
– Lower Per-Capita income, Higher inflation, and Higher External Debt --lower the country’s credit rating
– Sovereign debt to GDP is a key measure of the sustainability of government
debt (although credible governments can sustain high debt-to-GDP levels)
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Macro-economy and Sovereign Risk
Fiscal balance and external balance are relative to GDP. External debt refers to
foreign currency debt relative to exports.
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Sovereign Debt to GDP Ratio by Country
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External Debt and Default
• External debt (foreign debt) is debt held by foreigners
• External debt must be paid off with future current
account surpluses (excluding the possibility of default)
• External debt to GDP is a key indicator of sustainability
of external debt
• External debt to GDP rises
– if growth rate of GDP falls
– if the cost of external borrowing rises
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Sovereign Credit Default Swap (CDS) Spreads
The buyer of a CDS receives a payment if the credit instrument goes into default
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The Lesser-Developed Country (LDC) Debt Crises
• Prior to 1979, a run-up in commodity prices such as coffee and oil
led to an investment boom in many Latin American countries
• Consequently, many Latin American borrowed heavily and raised
the External Debt to GDP ratios
• Global recession in 1979-82 lowered demand for exports
• Interest rates on dollar denominated adjustable rate debt rose
• Debt to exports and debt to GDP rose dramatically
• In August 1982 Mexico declared a moratorium on interest
payments. This led to the debt crises
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Debt and Current Account 1979 and 1982
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Current Account Reversals
Current account rises (perhaps reverses from deficit to surplus) during a crisis
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Current Account as a share of GDP
15 Percent
10
Thailand
5
0
Indonesia
Malaysia
-5
-10
-15
1995
1996
1997
1998
199939
The Worldwide Real Interest Rate
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Capital Market Equilibrium
for the World Economy
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Global Capital Markets
Variables subscripted by w refer to global variables,
and those subscripted by arg refer to Argentina.
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An Increase in future TFP
Expectations of better growth prospects for the
future increase investment today
Investment determined by (i) real interest rate (ii) future prospects
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A Decline in Savings
A fall in Savings can raise the interest rate and lower investment
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