university of papua new guinea international economics lecture 14: national income accounting and...
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University of Papua New Guinea
International Economics
Lecture 14: National Income Accounting and the Balance of Payments
The University of Papua New GuineaSlide 2
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Overview
• Review: National income accounting
• The balance of payments accounts
• Review: Saving
• More on the current account…
• The twin deficits hypothesis
• Managing the accounts
The University of Papua New GuineaSlide 3
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Review: National income accounting
GDP measured by the expenditure method:
Y = C + I + G + (X-M)
– Y = Income
– C = Consumption
– I = Investment
– G = Government spending
– X = Exports
– M = Imports
Note: (X – M) is sometimes written as NX, meaning ‘net exports’
The University of Papua New GuineaSlide 4
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The balance of payments accounts
Current Account
+
Capital Account
=
Financial Account
The University of Papua New GuineaSlide 5
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The balance of payments accounts
Current account:
– X, M
– Interest/dividends coming in from
overseas investments and going out
from FDI (but not the FDI itself!!)
– Remittances, transfers…
+ve: Money coming in
–ve: Money going out
The University of Papua New GuineaSlide 6
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The balance of payments accounts
Capital account:• Tracks transfers of assets into or out of a
country
+ve: FDI, foreign loans, foreign aid (when
goods or services are attached)
–ve: ‘capital flight’
The University of Papua New GuineaSlide 7
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The balance of payments accounts
Financial account:
Sometimes called the cash account,
or the international reserves account
– Foreign cash reserves
– Gold
– Deposits with the IMF
– Finance from the IMF
– Acts as balancing item in balance of payments
IMF = International Monetary Fund;
Acts like the world’s reserve bank!
The University of Papua New GuineaSlide 8
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Credits and debits in the Balance of Payments Accounts
Note: Everything entering the balance of payments accounts gets entered twice – once as a debit, once as a credit
The University of Papua New GuineaSlide 9
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Review: Saving
Closed economy: S = Y – C – G = I
• Can only build up wealth through
developing its own capital stock
– I.e., domestic I
The University of Papua New GuineaSlide 10
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Review: Saving
Open economy: S = I + CA (‘Current Account’)
– Can build up wealth through domestic I,
or through acquiring foreign wealth
• I.e., purchasing foreign assets
– Because a country’s savings can be
borrowed by another, a current account
surplus is often called net foreign
investment
The University of Papua New GuineaSlide 11
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Review: Saving
Open economy (cont.)
• The current account is thus intertemporal trade
in consumption
– I.e., a current account deficit is where a
country borrows money – importing
consumption now – and pays off the money
later – exporting consumption in the future
• It’s the opposite with a current account surplus!
The University of Papua New GuineaSlide 12
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Review: Saving
Private saving: SP = Y – T – C [T = Tax]
• It is simply income that is saved and not
consumed!
Public saving: SG = T – G
• In any given year, if T > G, it a budget surplus
• If T < G, it is a budget deficit
The University of Papua New GuineaSlide 13
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Why care about the current account?
Current account balance
= X – M = NX [‘Net Exports’]
When X > M: current account surplus
When X < M: current account deficit
Note: Technically, the current account also includes net income (this is the ingoings and outgoings of dividends, interest, transfers,
and foreign aid when it is given as cash with no good or service attached)
So we are oversimplifying things when we think of CA = NX!
The University of Papua New GuineaSlide 14
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Why care about the current account?
1. Employment
• The equation Y = C + I + G + NX tells us
that the current account (NX) contributes to
output…
– …and thus employment!
The University of Papua New GuineaSlide 15
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Why care about the current account?
2. International borrowing
• It shows the size and direction of
international borrowing
– E.g. if the current account is –PGK 300million,
per month, then it is spending its export
earnings, and then borrowing 300million per
month to finance these extra imports
The University of Papua New GuineaSlide 16
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Why care about the current account?
• Thus, the current account balance is equal
to the change in its net foreign wealth
– Current account is a flow variable
– Net foreign wealth is the stock variable
• Tracking the current account over time
helps to identify if a country’s public and
private debt is sustainable or not!
The University of Papua New GuineaSlide 17
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Why care about the current account?
An analogy that may help:
• Think about the current account as the
withdrawals / deposits, and net foreign
wealth as the bank balance (which includes
international reserves – the rainy day fund
that can help prop up the currency!)
• If you keep withdrawing, you get into debt
• …and at some point, no-one will lend to
you any more!
The University of Papua New GuineaSlide 18
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
United States
The University of Papua New GuineaSlide 19
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The University of Papua New GuineaSlide 20
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Australia
The University of Papua New GuineaSlide 21
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Papua New Guinea
The University of Papua New GuineaSlide 22
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
2010 2011 2012 2013 2014 2015 2016 2017
($1,500)
($1,000)
($500)
$0
$500
$1,000
$1,500
Overall BoP balance (before oil price shock)
US
D m
illions
SurplusSurplus
Deficit
PNG: Balance of payments balance
Source: Paul Flanagan, ANU
The University of Papua New GuineaSlide 23
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
2010 2011 2012 2013 2014 2015 2016 2017
($2,000)
($1,000)
$0
$1,000
$2,000
$3,000
$4,000
$5,000
Overall BoP balance (before oil price shock) Net international reserves (IMF)
US
D m
illions
Surplus Surplus
Deficit
PNG: Balance of payments and international reserves
Source: Paul Flanagan, ANU
The University of Papua New GuineaSlide 24
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
2010 2011 2012 2013 2014 2015 2016 2017
($2,500)
($2,000)
($1,500)
($1,000)
($500)
$0
$500
$1,000
$1,500
Overall BoP balance (before oil price shock) Overall BoP balance (after oil price shock)
US
D m
illions
Deficit Emerging Balance of Payments
Crisis
PNG: Effect of oil price fall on balance of payments
Source: Paul Flanagan, ANU
The University of Papua New GuineaSlide 25
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
2010 2011 2012 2013 2014 2015 2016 2017
($3,000)
($2,000)
($1,000)
$0
$1,000
$2,000
$3,000
$4,000
$5,000
Overall BoP balance (before oil price shock)
Net international reserves (IMF)
Overall BoP balance (after oil price shock)
Net international reserves (after oil price shock)
US
D m
illions Emerging
International Reserves Crisis
Source: Paul Flanagan,
ANU
PNG: Effect of oil price fall on balance of payments and international reserves
The University of Papua New GuineaSlide 26
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The twin deficits hypothesis
• Argues that there is a strong link between
current account deficits, and government
budget deficits
• Some, tentative empirical evidence
supports the hypothesis
The University of Papua New GuineaSlide 27
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
The twin deficits hypothesis
• If we rearrange our savings and output
identities, we can get to:
• If there is a budget deficit, then (T – G) is
negative
• …and this means either investment is
crowded out (I), or there must be a (NX)
=> i.e., a worsening of the current account
The University of Papua New GuineaSlide 28
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Managing the accounts
• International reserves can finance deficits
(i.e., the rainy day fund!)
– But this is not a long-term solution!
• Improving the capital account:
– FDI, foreign aid, remittances
– Sound monetary and fiscal policy
The University of Papua New GuineaSlide 29
Lecture 14: National Income Accounting and the Balance of Payments Michael Cornish
Managing the accounts
• Improving the current account:
– Increase X earnings
– Decrease interest/dividend payments
going overseas
– Devaluation!
=> M, X (but keep imported
production inputs in mind!)
– Sound monetary and fiscal policy