tarun das lecture bop-2

8/9/2019 Tarun Das Lecture BOP-2

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UNSIAP TARUN DAS SESSION 9-10 BOP 1

Open Economy andBalance of Payments

Tarun Das, Eco Adviser, MOF, India


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2SESSION 9-10 BOPUNSIAP TARUN DAS

Contents

1. Macroeconomic balance sheet in anopen economy and two gap theory2. Macroeconomic balance sheet in an

open economy with governmentand Three gaps theory

3. Interrelations between BOP andGFS- A Case Study for the USA

4. A Numerical example on ThreeGaps Model on BOP

5. Workshop Session-1 on BOP


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1. Macroeconomic Balanceand Two-Gap Theory

Y = C + I + X M (1) Y = C + S (2)Where, Y = Income, C = ConsumptionI = Investment, S = Savings

X = Exports, M = ImportsEquating equations (1) and (2) we getC + S = C + I + X M(S I) = (X M ) (3)Savings - Investment gap (or ResourceGap on the domestic account) equalscurrent account balance (CAB).


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. acroeconom c a ance s eein an open economy with

government

Y = GNP = GDP + NFI (4)

GDP=(PubExp+PubInv+PvtExp+PvtInv+XM) (5)

Where

GNP = Gross national product

GDP = Gross domestic productPubExp = Public expenditure

PubInv = Public investment

PvtExp = Private expenditure

PvtInv = Private investment

X = Exports of goods and servicesM = Imports of goods and services

NFI = Net factor income from abroad


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2.2 Three Gaps Theory

Rearranging the terms of equations (4) and (5)

we getY = (PubExp + PubInv + PvtExp + PvtInv + X

M) + NFI (6)

Or, Y (PvtExp + PvtInv) =

(PubExp + PubInv) + (X M + NFI) (7)

Or, Y (PvtExp + PvtInv + T) =

(PubExp + PubInv - T) + (X M + NFI) (8)

Or, (X M + NFI) = [Y (PvtExp + PvtInv + T)]

+ [T (PubExp + PubInv)]


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(X M + NFI) = Current account balance =

Exports of goods and services minus imports ofgoods and services plus net factor incomes fromabroad

Y (PvtExp + PvtInv + T) =

Private sector balance = Income minus privateexpenditure minus private investment minustaxes paid to the government

T - (PubExp + PubInv) = Public sector balance

= Taxes minus Public expenditure minus publicinvestment


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Thus we get

Current account balance =Private sector balance +Public sector balance.

This means that persistent fiscal deficits

spill over the external current account inthe medium and long term having widespread impact on external capital flows,domestic investment, output and prices.

We would discuss a case study on the

interrelations between BOP and GFSaccounts and their macroeconomicimpact to have an economic insight ofthese statistics.


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3.1 A Case Study for USA

Interdependence in external trade domestic production, and finance

results in interdependence in demand andoverall economic performance.

Basic accounting equationsIncome Spending

= Net acquisition of financial assets= Balance of payments current account


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3.2 Financial balance in the worldeconomy today (Ave. CAB in billion

US$)

Every countrydesires to havesurpluses oncurrent account.

But, all the

countries can nothave surplusesat the sametime.

-500 -400 -300 -200 -100 0 100 200

Rest of Asia

W Europe

Japan

M East

Russia

China

Other devpd

Africa

Other America

E Europe

USA

Average current accountbalance in billion dollars

2000-2003


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3.3 A global imbalance of

unprecedented proportions

The USA hastoday the

largest evercurrentaccountdeficit.

0 200 400 600 80

Korea, 1996

Brazil, 1997

Australia, 2003

Mexico, 1994

UK, 1989

Hong Kong, 1996

USA, 2004

World's largest current account deficits since 1970

($ billion)


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3.4 Factors for USA Deficit

The deficit reflects

borrowing by the

US government and

households

Net lenders

Net borrowers

Corporate(3.3%)

Savings gap financedby the rest of world

(7%)

Govt (3.9%) Households (6.2%)

Lending andborrowing in 2005 first

half as % of USnational income


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3.5 USA- Personal borrowing

Since theearly 1990'sthe UScurrentaccountdeficit hasbeen drivenby the

householdsector.

55 60 65 70 75 80 85 90 95 00 05 10

8 %

4%

-4%

-8%

%

ofN

etNational

Incom

e

Current

Account

NetLendingPersonal

S.


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3.6 USA- the internal frontier

US citizens

have invested

hugely in realestate

financed by

mortgage

borrowings.

0

4

8

12

16

20

24

28

55 60 65 70 75 80 85 90 95 00 05 10

Trillion

US$

Real estateassets personal

sector

Debtpersonal

s.


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3.7 USA- $50 trillion of personalwealth

Average net worthis now $160,000per person.

Real estateaccounts for abouthalf of this total.

The investment

was paid off asproperty pricescontinued to rise.

Debt

Deposits &securities

Equity

Pensions

Assets

Realestate

Liabilities

Durables

NET

WORTH


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3.8 How did USA households become sorich?

Interestrateswere low

andfallingthroughthe1990s

Whilehousingpricescontinued to rise.

House

prices

relativ

e

toGDP

deflato

r

rate

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

4

6

8

10

12

14

16

18

20

1975 1980 1985 1990 1995 2000 2005

Relative houseprice

Mortgage int.rte.


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3.9 USA Government borrowed too

The govt has

generallybeen indeficit andactedcounter-cyclically

The deficitwas brieflyeliminatedin 2000

Since then

borrowinghas resumedto keep theeconomygrowing.

PSBR:

%

ofNNP

//Gr

owt h

:avg

%

rate2years

2yr.growthrate of

NNP

Government

Deficit

-2

0

2

4

6

8

1970 75 80 85 90 95 2000 05


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3.11 Over several years ofhouseholds and government

borrowing

The USA has

accumulatedover $12trillionliabilities to therest of theworld.

0

2

4

6

8

10

12

14

2000 2001 2002 2003 2004 2005

Total Assets

Total Liabilities

$ trillion, mid-

year


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3.12 How did foreigners financetheir investment in the USA ?

They earned themoney by sellinggoods, servicesand assets with

substantial profitmargins. Capital inflow=

current outflow+ capital

outflow

0

1

2

3

4

5

6

2000 2002 2004

Capital inflow

Current outflow

$ trillioncumulative

flow from mid-2000

surplus ongoods andservices

assets soldto the USA


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0

40

80

120

160

1990 1995 2000 200

Non-farm employment, millions

3.14 It didn't cost US overall

jobs. Losses in

output and

employmentinmanufacturingwere faroutweighedby gains inservices.

private serviceemployment

governmentother industries

manufacturing

Unemployment rate


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3.15 The USA current accountdeficit Directly adds around

1.5% to income of therest of the world.

The gain is muchbigger for some of the

partners.

Allocation of USAdeficit amongpartners as % ofpartners GDP isindicated in the chart. 0 2 4 6

W Europe

China

Other Asia

Other America

Other Devpd


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3.16 This solves some problems from the past

Trade deficits

Borrowing

Currency crisis

Financialadjustment

-3%

-1%

1%

3%Africa

L Amer

Oth Asia

China

M East

CP

Oth dev

Japan

W Eur

USA1980

1996

Currentaccountbalances asper cent ofworld exports


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3.17 Reliance of the ROW on the USA

US householdsand govt borrow,

providingliquidity for thewhole world

Banks and

financial marketsrecycle savingsfrom the rest ofthe world to theborrowers in theUSA

USA

Restofworld

Financial

markets

borrowing

savin

g

spending

Goods &services

earnin

g

or ou ess on: e o ow ng


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. or ou ess on: e o ow ngdata relate to Indian economy for the year2003-04.

Items (Rupeesbillion)

1.GNP 27459

2.Public Expend (PubExp) 31213.Private Expend (PvtExp) 17353

4.Public Invest (PubInv) 1802

5.Private Invest (PvtInv) 5680

6.Public savings (PubSav) 284

7.Private savings (PvtSav) 7695


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4.2 Workout Session: The followingdata relate to Indian economy for the year

2003-04.

Items (Rupeesbillion)

8.Taxes less subsidies (T) 2402

9.Exports of goods & services (X) 4078

10.Imports of goods and services(M)

4434


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4.3 Workout Session: QuestionGiven above data, estimate the

following:1. GDP at current market prices

2. Net factor income from abroad

3. Current account balance4. Private Investment-Savings gap

5. Public Investment-Savings gap

6. Overall Investment-Savings gap7. Private account balance

8. Public account balance


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4.4 Numerical Question9. Examine the following identities:

(a) Overall Investment-savings gap(or resource gap on the domesticaccount) equals current accountbalance (CAB)

(b) Current account balance equalsprivate sector balance plus publicsector balance.

Use Excel File UNSIAP TarunDas Session-10 GFSWorkshop-1


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Thank you

Have a Good Day

tarun das lecture bop-2

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