Download Current account

Chapter 9
Trade and
the Balance
of Payments
Learning Objectives
• Define the current and financial accounts of
a country’s trade and payments.
• List and explain the importance of the three
components of the current account.
• List and explain the importance of three
main types of international capital flows.
• Use a simple algebraic model to relate the
current account to savings, investment, and
the general government budget balance.
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9-2
Learning Objectives
(cont.)
• Discuss the pros and cons of current
account deficits.
• Define a country’s international investment
position and relate changes in it to the
current account balance.
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9-3
Introduction:
The Current Account
• The international transactions of a nation
are divided into three separate accounts
– Current account: record of the goods and
services into and out of the country
– Financial account: record of the flow of
financial capital to and from the country
– Capital account: record of some specialized
types of relatively small capital flows
• Let’s examine each of these in greater
detail…
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The Trade Balance
• Let’s first define the trade balancemeasures the difference between exports and
imports of goods and services
– Trade deficit: negative trade balance
• In 2008, the U.S. had a trade deficit of $695.0 billion
– Trade surplus: positive merchandise trade balance
• However, the U.S. had a large trade surplus in services
($144 billion)
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The Current Account Balance
• Current account balance: Measures all current,
non-capital transactions between a nation and the
rest of the world
• The current account has three main components:
– Goods and services = the value of goods and
services exported – the value of imports
– Investment income = income from investments
abroad – income paid to foreigners on their U.S.
investments
– Unilateral transfers = any foreign aid or other
transfers received by foreigners – that given to
foreigners
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TABLE 9.1 Components of the
Current Account
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TABLE 9.2 The U.S. Current
Account Balance, 2011
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FIGURE 9.1 U.S. Current Account
Balances, 1960-2011
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U.S. Current Account Balance
• Large deficits in the current account began
around 1982, and have been more or less a
constant feature of the U.S. economy since
• The second began in the early 1990s and
continues today
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U.S. Current Account Balance
(cont.)
• A current account deficit is not a sign of
weakness: in the U.S., the economic boom of
the 1990s increased the demand for imports,
while sluggish growth abroad limited the
expansion if U.S. exports
• However, everyone agrees the U.S. deficit is
not sustainable in the long term
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9-11
Introduction to the
Financial and Capital Accounts
• Financial account: A record of the flow of
financial capital to and from a country
• Financial account is divided into three
categories:
– Net changes in the country’s assets abroad
– Net changes in the foreign-based assets in the
country
– Net change in financial derivatives
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Introduction to the Financial and
Capital Accounts (cont.)
• Assets include bank accounts, stocks and
bonds, and real property such as factories,
businesses, and real estate
• Financial derivatives are complex
financial contracts traded in a variety of
forms; until recently they were not included
in the balance of payments
• Value of financial derivatives is derived
from the value of a variable such as
interest rates, exchange rates, or
commodity prices
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Introduction to the Financial and
Capital Accounts (cont.)
• Capital account: A record of the transfers
of specific types of capital, such as:
– Debt forgiveness
– Personal assets that migrants take with them
abroad
– The transfer of real estate and other fixed
assets, such as a military base or an embassy
building
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Introduction to the Financial and
Capital Accounts (cont.)
Two points about the capital and financial accounts:
•First, both accounts present the flow of assets during
the year, not the stock of assets that have
accumulated
•Second, all flows are “net” changes rather than
“gross” changes
•Net changes are informative because they measure
the monetary value of the change in a country’s
financial stake in foreign economies
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Introduction to the Financial and
Capital Accounts (cont.)
• Three accounting caveats:
1. Both the capital account and the financial
account present the flow of assets during the
year in question and not the stock of assets that
have accumulated over time
2. All flows are net changes (differences between
assets sold and bought, for example) rather than
gross (stock) changes
3. As long as the capital account balance is zero,
financial account balance = current account
balance, but with the opposite sign
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Introduction to the Financial and
Capital Accounts (cont.)
• The current, capital, and financial accounts
are interdependent
• Current account measures flow of goods and
services
• Capital and financial accounts measure flow
of financing
• Therefore, sum of capital account and
financial accounts equal to current account
with opposite sign
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TABLE 9.3 The
U.S. Balance of
Payments, 2011
• Balance of payments =
current account +
capital account +
financial account
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Statistical Discrepancy in the
Balance of Payments
• Statistical discrepancy: The amount by
which the sum of the current, capital, and
financial accounts is off the total of zero
• Statistical discrepancy is calculated as the
sum of the current, capital, and financial
accounts, with the sign reversed
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Statistical Discrepancy in the
Balance of Payments (cont.)
• Statistical discrepancy exists because the
record of all the transactions in the balance
of payments is incomplete
– Errors tend to lie in the financial account
calculation, as it is the hardest to measure
correctly
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TABLE 9.4 Components of the U.S.
Financial Account, 2011
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Types of Financial Flows
• Financial flows originate in the public and
private sectors
• Some financial flows are very mobile and
represent short-run tendencies:
– Mobility of financial flows brings economic
volatility
– Upon sudden financial outflows, a country can
sink into a financial crisis
– The volatility of financial flows has increased
concern about the various types of flows
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Types of Financial Flows
(cont.)
1. U.S. assets abroad (outflows)
A. Official reserve assets: currencies of the
largest and most stable economies (US dollars,
EU euros, British pounds, Japanese yen including
gold and Special Drawing Rights SDR)
B. U.S. Government assets: loans and
rescheduled loans to foreign governments,
received on outstanding loans, changes in nonreserve currency holdings (e.g., Mexican pesos)
C. U.S. Private assets: direct investment, foreign
securities, loans to foreign firms and banks
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Types of Financial Flows
(cont.)
2. Foreign assets in the U.S. (inflows)
A. Foreign official assets: gold bullion, IMF´s
special drawing rights (SDRs), major
currencies
B. Other foreign assets: direct investment,
U.S. securities and currency, loans to U.S.
firms and banks
3. Net change in financial derivatives
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Types of Financial Flows
(cont.)
• Subcomponents of private assets: foreign direct
investment (FDI), foreign securities, loans to
foreign firms and banks
– FDI: tangible items: real estate, factories, warehouses,
transportation facilities, and other physical (real) assets
– Securities and loans can be considered foreign portfolio
investment - paper assets such as stocks and bonds
– Both FDI and foreign portfolio investment- claim in a foreign
economy’s future output; FDI have longer time horizons
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TABLE 9.5 Private Flows in the U.S.
Financial Account, 2011
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Role of Expectations in
Financial Flows
• Shifts in expectations can lead to sudden
stoppages of financial inflows
• The result is a destabilizing of outflows of
financial capital
• This occurrence has been labeled a sudden
stop
• Sudden stops have been involved in the
most financial crises in last 30 years
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Limits on Financial Flows
• Until recently, most nations limited the
movement of financial flows related financial
account transactions across their borders
– The European Union liberalized financial flows
between member countries only in 1993
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Limits on Financial Flows
(cont.)
• The movement toward open markets over
the 1980s and 1990s resulted in the lifting
of controls on financial flows
– Developing countries, in particular, have
liberalized financial account transactions in order
to get access to financial capital for development
– Although financial flows can be volatile,
economists agree that free flows are best for
economic efficiency
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TABLE 9.6 The U.S Financial Accounts,
2007-2008 (Billions of Dollars)
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Quiz
• Bases on Table 9.6, compare the financial account
flows pre- and post- the 07-08 financial crisis.
• What can you say about the flows of U.S. owned
assets abroad? Are they due to public or private
flows? What reasons do you think can help to
explain the change of flow patterns?
• What about the flows of foreign owned assets in the
U.S.? Are they due to public or private flows? Why
the patterns change in some categories but not
others?
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The Current Account and
the Macroeconomy
• Why study the balance of payments?
– Balance of payments help understand the
broader implications of current account
imbalances and how to tame current account
deficits
– Balance of payments give cues how nations can
avoid crises brought by volatile financial flows
and how they can minimize the damage of
financial crises if such occur
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The National Income and
Product Accounts
• National income and product accounts (NIPA):
internal, domestic accounting systems the countries
use to keep track of total production and total
income
• Two fundamental concepts of the system:
– Gross domestic product (GDP): the value of all final
goods and services produced within a country’s borders
during a period of time (usually a year)
– Gross national product (GNP): the value of all final
goods and services produced by the labor, capital, and
other resources of a country within the country as well as
abroad
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The National Income and
Product Accounts (cont.)
• GNP = GDP + foreign investment income
received – investment income paid to
foreigners + net unilateral transfers
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Table 9.7 Variable Definitions
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The National Income and
Product Accounts (cont.)
• Interplay of the variables of the national accounts
1. GDP = C + I + G + X – M
2. GNP = GDP + (net foreign investment income + net transfers)
3. GNP = (C + I + G) + (X – M + net foreign investment income +
net transfers)
4. GNP in terms of current account balance:
GNP = C + I + G + CA
5. GNP is also the value of income received: GNP = C + S + T
6. Since 4 and 5 are equivalent definitions of GNP,
C + I + G + CA = C +S + T
7. I + G + CA = S + T
8. S + (T – G) = I + CA
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The National Income and
Product Accounts (cont.)
• S + (T – G) = I + CA summarizes the
current account balance, investment, and
public and private savings in the economy
• The following figure illustrates the equation
in the U.S. in 1990-2007
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FIGURE 9.2 U.S. Savings and
Investment, 1990–2010
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The National Income and
Product Accounts (cont.)
• The four macroeconomic variables
demonstrate there is not a fixed relationship
between the current account balances and
government budget balances, or between
savings and investment
• The four variables are determined by the
other three
• A change in any one of them influences all of
them
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Are Current Account
Deficits Harmful?
• The relationship between the current
account balance, investment, and total
national savings is an identity
• Consequently, it does not tell us why an
economy runs a current account deficit or
surplus
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International Debt
• Debt is defined as money owed to
nonresidents with must be paid in a foreign
currency
• Current account deficits must be financed
through inflows of financial capital (loans)
• Loans from abroad add to a country’s stock
of external debt and generate debt
service obligations
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International Debt
(cont.)
• All countries, rich and poor, have external
debt
• In many low and middle income countries,
external debt leads to financial problems
• Unsustainable debt occurs for numerous
reasons:
–
–
–
–
Sudden drop in commodity prices
Natural disasters
Corruption
Foreign lending behavior
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The International
Investment Position
• When a country runs a current account
deficit, it borrows from abroad and increases
its indebtedness
• If a country runs a current account surplus,
it lends to foreigners and reduces its overall
indebtedness
• International investment position =
domestically owned foreign assets –foreign
owned domestic assets
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The International
Investment Position
(cont.)
The International Investment Position
•Total of all domestic assets owned by
foreigners, subtracted from the total of all
foreign assets owned by residents of the home
country
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The International
Investment Position
(cont.)
Costs and benefits of capital inflows
- enables countries to invest more
- makes it possible for governments and
consumers to spend more (save less)
- capital inflows take the form of direct
investment, may bring new technologies
(technology transfer)
- new management techniques
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