Download Open Economy

MIBE
The economics of emerging economies
The role of Finance in economic
development and the emerging economies
Gianni Vaggi, April 2014
Finance 3-1
National accounting in an open
economy
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…