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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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UNSIAP TARUN DAS SESSION 9-10 BOP 3
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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UNSIAP TARUN DAS SESSION 9-10 BOP 4
. 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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UNSIAP TARUN DAS SESSION 9-10 BOP 5
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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UNSIAP TARUN DAS SESSION 9-10 BOP 6
2.3 Three Gaps Theory
(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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UNSIAP TARUN DAS SESSION 9-10 BOP 7
2.4 Three Gaps Theory
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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UNSIAP TARUN DAS SESSION 9-10 BOP 8
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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UNSIAP TARUN DAS SESSION 9-10 BOP 9
3.2 Financial balance in the worldeconomy today (Ave. CAB in billion
US$)
Every countrydesires to havesurpluses oncurrent account.
But, all the
countries can nothave surplusesat the sametime.
-500 -400 -300 -200 -100 0 100 200
Rest of Asia
W Europe
Japan
M East
Russia
China
Other devpd
Africa
Other America
E Europe
USA
Average current accountbalance in billion dollars
2000-2003
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UNSIAP TARUN DAS SESSION 9-10 BOP 10
3.3 A global imbalance of
unprecedented proportions
The USA hastoday the
largest evercurrentaccountdeficit.
0 200 400 600 80
Korea, 1996
Brazil, 1997
Australia, 2003
Mexico, 1994
UK, 1989
Hong Kong, 1996
USA, 2004
World's largest current account deficits since 1970
($ billion)
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UNSIAP TARUN DAS SESSION 9-10 BOP 11
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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UNSIAP TARUN DAS SESSION 9-10 BOP 12
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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UNSIAP TARUN DAS SESSION 9-10 BOP 13
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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UNSIAP TARUN DAS SESSION 9-10 BOP 14
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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UNSIAP TARUN DAS SESSION 9-10 BOP 15
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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UNSIAP TARUN DAS SESSION 9-10 BOP 16
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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UNSIAP TARUN DAS SESSION 9-10 BOP 18
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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UNSIAP TARUN DAS SESSION 9-10 BOP 19
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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UNSIAP TARUN DAS SESSION 9-10 BOP 21
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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UNSIAP TARUN DAS SESSION 9-10 BOP 22
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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UNSIAP TARUN DAS SESSION 9-10 BOP 23
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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UNSIAP TARUN DAS SESSION 9-10 BOP 24
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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UNSIAP TARUN DAS SESSION 9-10 BOP 25
. 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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UNSIAP TARUN DAS SESSION 9-10 BOP 26
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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UNSIAP TARUN DAS SESSION 9-10 BOP 27
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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UNSIAP TARUN DAS SESSION 9-10 BOP 28
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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UNSIAP TARUN DAS SESSION 9-10 BOP 29
Thank you
Have a Good Day