Current Account
Net Savings = Net Exports
• Capital Account = I – S
• Trade Balance: Net Exports = NX = X – IM
• GDP = C+ I+ G + X – IM = A + NX
Pacific Trade Imbalance
Trade Balance (as share of GDP)
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
China(Yuan
Renminbi)
Japan(Yen)
United
States(Dollars)
Current Account
• The current account is, conceptually, the amount
of income earned overseas less the amount of
income earned by foreigners from the domestic
economies.
Current Account =
Balance on Goods
(Goods ExportsGoods Imports)
+ Balance on
Services
(Services ExportsServices Imports)
+ Net Investment
Income
(Investment Income
Earned Overseas –
Investment Income
Paid to Foreigners)
+Net Transfers
(Donations from
Overseas)
US Trade Account
Millions of Dollars
Current Account
2005
Exports of goods and services and income receipts
$1,749,892
Exports of goods and services
$1,275,245
Goods, balance of payments basis/2/
$894,631
Services/3/
$380,614
Income receipts
$474,647
Imports of goods and services and income payments
-$2,455,328
Imports of goods and services
-$1,991,975
Goods, balance of payments basis/2/
-$1,677,371
Services/3/
-$314,604
Income payments
-$463,353
Unilateral current transfers, net
-$86,072
Sum
Source: BEA U.S. International Transactions
-$791,508
Capital & Financial Account
• The capital account (more accurately the capital &
financial account) records capital inflows into the
country.
Capital
&
Capital
Account
Financial
Account
+ Financial
Account →
+ Change in
Reserve Assets
(Debt Forgiveness, Patents)
Direct Investment
(FDI of Foreign Companies – FDI
by Domestic Companies)
+ Portfolio
Investment
(Domestic Securities Purchases by
Foreigners – Foreign Securities
Purchases by Domestic Residents)
+ Other
Investments
(Deposits in Domestic Banks by
Foreigners – Deposits in Foreign
Banks by Domestic Residents)
-Accumulation of Foreign
Exchange Reserves
Capital Account
Capital and financial account
Capital account
2005
-$4,351
Capital account transactions, net
Financial account
-$426,801
$14,096
$5,539
-$446,436
-$9,072
-$180,125
-$44,221
-$213,018
U.S.-owned assets abroad, net (increase/financial outflow (-))
U.S. official reserve assets, net
U.S. Government assets, other than official reserve assets, net
U.S. private assets, net
Direct investment
Foreign securities
U.S. claims on unaffiliated foreigners reported by U.S. nonbanking concerns
U.S. claims reported by U.S. banks, not included elsewhere
$1,212,250
$199,495
$1,012,755
$109,754
$199,491
$474,140
$19,416
$30,105
$179,849
Foreign-owned assets in the United States, net (increase/financial inflow (+))
Foreign official assets in the United States, net
Other foreign assets in the United States, net
Direct investment
U.S. Treasury securities
U.S. securities other than U.S. Treasury securities
U.S. currency
U.S. liabilities to unaffiliated foreigners reported by U.S. nonbanking concerns
U.S. liabilities reported by U.S. banks, not included elsewhere
Sum
Statistical discrepancy (sum of above items with sign reversed)
Source: BEA U.S. International Transactions
$781,098
$10,410
Define Financial Wealth of
Households and Government
P
t
• Private financial wealth is B
which
includes the sum of household and
business savings.
• Government financial wealth is BtG
• Net domestic financial wealth is foreign
assets:
F
G
P
Bt  Bt  Bt
Current account is the change in foreign
wealth.
• The private sector increases its financial
wealth through saving net of investment.
BtP  BtP1  StP  I t  Yt  rBtP1  TAX t  Ct  I t
• The public sector increases its financial
wealth through taxes net of transfer payments
and government spending.
BtG  BtG1  TAX t  rBtG1  Gt
• The economy increases its financial wealth
through the current account.
 B  B    B  B   TAX  rB  G   Y  rB  TAX  C  I 
 B  B   Y  rB  G  C  I   NX  rB
P
t
P
t 1
G
t
G
t 1
F
t
F
t 1
t
F
t 1
G
t 1
t
t
t
t
t
t
t
F
t 1
P
t 1
t
t
t
Savings & Investment Schedules
r
S(r)
I(r)
S,I
Metzler Diagram for a Small
Economy
• In an economy open to international
financial markets, real interest rate will be
set outside the economy.
• The savings and investment decisions of a
sufficiently small economy will not impact
the world real interest rate.
• Current account will be the gap between
saving and investment.
Savings & Investment Schedules
r
S(r)
CA
rW
I(r)
S,I
Savings & Investment Schedules
r
S(r)
rW
-CA
I(r)
S,I
Investment Boom: Current
Account Deficit
r
S
I
rW
I´
-CA
LF
Expansionary Fiscal Policy: Current
Account Deficit
r
S´
S
I
rW
-CA
LF*
LF
World Interest Rates Fall: Current
Account Deficit
r
S
I
rW
rWW
-CA
LF*
LF
Calculate the present value of trade
balances.
• Discount each budget constraint by the real
interest rate
BtF
BtF1
NX t
B  (1  r ) B  NX t 


 xt  xt 1  yt
t
t 1
t
(1  r ) (1  r )
(1  r )
F
t
F
t 1
• Recursively add this up.
x0  y0  x1 , x1  y1  x0 , x2  y2  x1 , x3  y3  x2 , x4  y4  x3
 x1  y0  y1  y2  y3  y4  ....
(1  r ) BF1  NX 0 
NX 3
NX 1
NX 2
NX 4



 .....
2
3
4
1  r (1  r ) (1  r ) (1  r )
• Current net foreign financial wealth is
equal to negative present value of the
trade balance.
• When an economy has a lot of foreign
assets, they can use income from these
assets to buy goods in the future.
• When they have a lot of foreign debts,
they must sell excess goods to earn
income to pay these debts.
Real Exchange Rate and Net
Exports
• Are net exports a
decreasing function of the
real exchange rate?
• Assume real imports are
a (positive) constant
elasticity function of real
exchange rate and
exports are a (negative)
constant elasticity
function
IM
s
IM
s
  IM
S  PF
s
P
X
s
X
s
  EX
Marshall-Lerner Conditions
• Real Net Exports
P  X  S  P F  IM
rnx 
 X  sIM
P
• Effect of a Change in Real Exchange Rate
rnx   X  sIM  X
IM
rnx
X
sIM


s
 IM 
 X
 ( IM  1)
s
s
s
s
s
s
s
• Near trade balance rnx=0
rnx
X
sIM
 X
 ( IM  1)
  X   IM   1 IM
s
s
s
Marshall-Lerner Conditions
• Marshall-Lerner Condition: An increase in
the relative price of foreign goods
increases real net exports if
• Two effects:
 X   IM   1  0
– Expenditure Switching: A rise in the relative
price of domestic goods will cause people to
purchase more imports and reduce exports.
– A rise in the price of domestic goods
increases the value of those goods in trade.
Long Run Elasticities
• Elasticities are % change in variable
caused by a % change in another variable.
• A variable may have different effect at
different horizons depending on
adjustment costs and inertia.
• Allow for dynamics in an equation
describing the effects.
Does Marshall-Lerner Condition
Hold
• In the short run, No.
In the long run yes.
ln X t   X ln st   X ln X t 1
ln IM t   IM ln st   IM ln IM t 1
 X  IM  1
X
 IM

1
1   X 1   IM
In 1984, Finance ministers of major economies met
in Plaza Hotel in NY to conspire to weaken US
dollar. US Current Account initially weakened.
USA
.012
.011
.010
.00
.009
-.01
.008
-.02
.007
-.03
-.04
82
83
84
85
86
87
88
89
Trade Balance (% of GDP)
90
91
S
92
J-Curve
rnx
s
time
Real Exchange Rate
NX
s
S-I
Real Exchange Rate and Net
Exports
•
An increase in the real exchange rate has counterveiling effects on net exports.
1. The value/price of a given amount of export goods will
rise relative to a given amount of import goods when
domestic goods increase in relative price.
•
An economy exports 100 apples at price of $1 each and imports 100
oranges at price of $1. Net exports are zero. If price of apples goes to
$2, then net exports will increase to 100.
2. When relative price of domestic goods increases, the
domestic economy will export fewer goods and import
more goods.
•
•
In very short run, the first effect will dominate.
In medium to long run, the second effect tends to
dominate.
Final Exam
•
•
•
•
When 18/12/07 (FRI)
What time? 8:30-11:30 (am)
Where?
3007
What to Bring? Calculator, writing
instruments, 1 sheet of paper, handwritten,
• Coverage: Fiscal Policy, Money and
Inflation, Business Cycles/ASAD, New
Classical, Current Account