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CHAPTER 5

CHAPTER 5. Saving And Investment In The Open Economy. Balance of Payments. BOP: The record of a country's international transactions. Any transaction that involves a flow of money into the United States is a credit (+) item (enters with a plus sign); for example, exports

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CHAPTER 5

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  1. CHAPTER 5 Saving And Investment In The Open Economy

  2. Balance of Payments BOP: The record of a country's international transactions. • Any transaction that involves a flow of money into the United States is a credit (+) item (enters with a plus sign); for example, exports • Any transaction involving a flow of money out of the United States is a debit (-) item (enters with a minus sign); for example, imports

  3. The Current Account • 1. Net exports of goods and services • Exports of goods - imports of goods = merchandise trade balance • 2. Net income from abroad • Income received from abroad = a credit item • Payment of income to foreigners = a debit item • Net income from abroad = NFP, net factor payments • Net unilateral transfers • Transfers from foreigners vs Transfers to foreigners • 1 + 2 + 3 = the current account balance • Positive = Current Acct surplus Negative = Current Acct deficit

  4. The Capital and Financial Account • The capital and financial account • - records trades in existing assets, either real (for example, houses) or financial (for example, stocks and bonds) • The capital account • - records the net flow of unilateral transfers of assets into the country. • Most transactions appear in the financial account part: • When home country sells assets to foreign country, that is a capital inflow for the home country and a credit (+) item. • When assets are purchased from a foreign country, there is a capital outflow from the home country and a debit (-) item.

  5. Current Account vs Capital Account Current account balance (CA) + capital and financial account balance (KFA) = 0 CA + KFA = 0 by accounting; every transaction involves offsetting effects. In practice, measurement problems, recorded as a statistical discrepancy, prevent CA + KFA = 0 from holding exactly.

  6. Net Foreign Assets Net foreign assets = foreign assets - foreign liabilities. Current account surplus = The net increase in foreign assets. A current account surplus = a capital and financial account deficit. = Net increase in holdings of foreign assets (a financial outflow) A current account deficit = a capital and financial account surplus. = Net decline in holdings of foreign assets (a financial inflow) Current account surplus = capital and financial account deficit = net acquisition of foreign assets = net foreign lending = net exports.

  7. Foreign Lending vs Borrowing

  8. A Decrease In Current Account Surplus A temporary adverse supply shock = Temporary drop in income leads to a drop in saving, so net foreign lending declines. An increase in the expected future marginal product of capital = Desired investment rises, so net foreign lending falls.

  9. Saving and Investment in a Small Open Economy Small open economy: an economy too small to affect the world real interest rate. World real interest rate (rw): the real interest rate in the international capital market. Residents of the small open economy can borrow or lend at the expected world real interest rate .

  10. Saving and Investment in Large Open Economies The world real interest rate moves to equilibrate desired international lending by one country with desired international borrowing by the other.

  11. Fiscal Policy vs Current Account The response of national saving: An increase in the government budget deficit raises the current account deficit only if the increase in the budget deficit reduces desired national saving, the saving curve shifts left, thus reducing the current account balance. A deficit caused by increased government purchases: The deficit reduces national saving = The current account balance declines. A deficit resulting from a tax cut = Sd falls only if Cd rises Sd won't change if Ricardian equivalence holds, since then a tax cut won't affect consumption but if people don't foresee the future taxes implied by a tax cut today, they will consume more, desired saving will decline, and so will the current account balance.

  12. End of Lecture 1 Week 15 Balance of Payments Current Account vs Capital & Financial Accounts Net Foreign Assets Foreign Lending vs Borrowing A Decrease in Current Account Surplus Saving and Investment In A Small Open Economy Saving and Investment In Large Open Economies Fiscal Policy vs Current Account

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