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Macroeconomics in the Global Economy Session 3. The Open Economy Trade and Capital Flows Balance of Payments Saving, Investment and the Current Account
Macroeconomics in the Global Economy
Session 3. The Open Economy
Trade and Capital Flows
Balance of Payments
Saving, Investment and the Current Account
Macroeconomics in the Global Economy
1. Trade Flows
020406080
100120140160180
Singapore Ireland Mexico Italy Turkey Japan USA Brazil
% o
f GD
P
Exports Imports
2015
Macroeconomics in the Global Economy
3. Capital Flows
Foreign Direct Investment. Involves significant ownership in foreign company or establishment of foreign operations.
Portfolio investment: foreign debt and equity (without control).
Change in official (foreign) reserves: portfolio investment under the control of the government or central bank.
2. Income Flows: Net Factor Payments
Worker’s remittances
Unilateral government transfers.
Repatriation of profits.
Macroeconomics in the Global Economy
Exports (+)
Imports (-)
Net factor payments
Current Account Capital and Financial Account
Changes in foreign reserves**
Change in domestic holdings of foreign assets
Change in foreign holdings of domestic assets
Acquisition (-)Sale (+)
Acquisition (+)Sale (-)
Acquisition (-)Sale (+)
Balance of payments: stylized version
** See definition in next slide
Macroeconomics in the Global Economy
Foreign Reserves
Foreign (Official) Reserves: Liquid assets owned by the monetary authority (or government) for international payments, liquidity needs, foreign exchange intervention, current account crisis.
Traditionally Foreign Reserves only included cash, foreign bank deposits and foreign government securities.
As foreign reserves grew fast in the last 15 years, these assets get treated as any other investment. Sovereign Wealth Funds take over the management of these assets. Assets become illiquid.
There is therefore some uncertainty about what qualifies as “foreign reserves” when you compare countries’ balance of payments.
Macroeconomics in the Global Economy
A country’s balance of payments accounts keep track of both its payments to and its receipts from foreigners.
All transactions produce two records of opposite sign and the balance is always zero:
Current account + Capital and Financial Account = 0
For example, a current account deficit can be financed by either
In all cases these changes appear as a surplus in the Capital and Financial Account.
FDI inflow orBorrowing from foreigners orSale of foreign assets orDecrease of foreign reserves
Balance of Payments: A Balanced Imbalance
Macroeconomics in the Global Economy
Exports of goods (+)Imports of goods (-)
Goods Trade Balance
Exports of services (+)Imports of services (-)
Services Trade Balance
Net exports
Net Factor Payments
Current Account
Other financial flows
Change in Foreign Reserves
Foreign direct investment
Private Capital Flows
223
15
238
287
-472
186
Negative numbers mean an increase in reserves!
-185Capital and Financial AccountErrors and Omissions -53
Balance of PaymentsChina 2010 – Billions USD
101
246
-23
Macroeconomics in the Global Economy
Exports of goods (+)Imports of goods (-)
Goods Trade Balance
Exports of services (+)Imports of services (-)
Services Trade Balance
Net exports
Net Factor Payments
Current Account
Other financial flows
Change in Foreign Reserves
Foreign direct investment
Private Capital Flows
385
-54
331
-485
342
62
Positive numbers mean a decrease in reserves!
-143Capital and Financial AccountErrors and Omissions -188
Balance of PaymentsChina 2015 – Billions USD
-547
567
-182
Macroeconomics in the Global Economy
In an open economy saving does not need to be equal to investment:
GDP = C + G + I + NX(GDP+NFP) - C – G = I + (NX + NFP)
S = I + CA, or(Sprivate- Iprivate) + (Sgovernment – Igovernment)= CA
As an example: An increase in the government budget deficit must be accompanied by:
An increase in private saving orA decline in investment orA current account deficit
Saving, Investment and the Current Account
Macroeconomics in the Global Economy
(SPrivate- IPrivate) + (SGovernment – IGovernment) = CASaving, Investment and the Current Account
(% of GDP) Private SectorBalance
GovernmentBalance
CurrentAccount
2007 United States -2.2 -2.8 -5.0
Japan 7.0 -2.1 4.9
Greece -7.7 -6.7 -14.4
2012 United States 5.6 -8.3 -2.7
Japan 11.1 -10.1 1.0
Greece 2.9 -6.3 -3.4
2016 United States 1.6 -4.1 -2.5
Japan 8.9 -5.2 3.7
Greece 3.4 -3.4 0
Macroeconomics in the Global Economy
-16
-12
-8
-4
0
4
8
12
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
(% o
f GD
P)
Current Account Govt. Budget balance Net private saving
Saving, Investment and the Current Account (US)
Macroeconomics in the Global Economy
r
Saving, Investment
Investment
Saving
WorldReal interestrate
CA surplus
Saving and Investment in a Small Open EconomyCountries with excess saving (relative to investment) run current account surpluses. Remember that when S > I, it means that spending (C + I +G) is smaller than income (GDP+NFP).
Macroeconomics in the Global Economy
r
Saving, Investment
Investment
Saving
WorldReal interestrate
CA deficit
Saving and Investment in a Small Open EconomyCountries with excess investment (relative to saving) run current account deficits. Remember that when S < I, it means that spending (C + I +G) is greater than income (GDP+NFP).
Macroeconomics in the Global Economy
r
Saving, Investment
Investment
Saving
WorldReal interestrate
CA surplusr
Saving, Investment
Investment
Saving
CA deficit
Saving and Investment: The World Economy
World equilibrium requires that sum of deficits = sum of surpluses. Interest rates need to adjust to make this happen.
Macroeconomics in the Global Economy
r
Saving, Investment
Investment
Saving
Real interestrate (1990s)
CA surplusr
Saving, Investment
Investment
Saving
CA deficit
Real interestrate (2000s)
Saving (New)
Saving Glut: Global Imbalances
An increase in saving in some countries will produce a decreases in interest rates (Session 2) and an increase in Global Imbalances
Macroeconomics in the Global Economy
Saving Glut and Interest Rates
-1
0
1
2
3
4
5
6
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
10 Year Global Real Interest Rate
Global Interest Rate decrease when global saving increased
Macroeconomics in the Global Economy
-3
-2
-1
0
1
2
3
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Cur
rent
Acc
ount
as %
of W
orld
GD
P
OIL Germany and Japan China and Emerging Asia
Income - Spending
Saving Glut and Global Imbalances
Macroeconomics in the Global Economy
-3
-2
-1
0
1
2
3
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Cur
rent
Acc
ount
as %
of W
orld
GD
P
US Europe Deficit
Income - Spending
Europe Deficit: Bulgaria, Greece, Hungary, Ireland, Portugal, Spain, UK,…
Saving Glut and Global Imbalances
Macroeconomics in the Global Economy
-3
-2
-1
0
1
2
3
419
96
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Cur
rent
Acc
ount
as %
of W
orld
GD
P
US Europe Deficit OIL Ger and Jap China and Em. Asia Others
Income - Spending
Saving Glut and Global Imbalances
Macroeconomics in the Global Economy
Gross vs Net Capital Flows
China USAForeign Assets: 57% 128%
Out of which Reserves: 31% 2%Foreign Liabilities: 42% 168%Net International Investment Position: 15% -40%
All figures measured as % of GDP. End of 2015.
China is not the only country with a large Net International Investment Position. Germany NIIP= 49%; Singapore NIIP=182%.
While we typically focus on net flows, there are interesting dynamics in gross flows as well.The US can be seen as leveraging by borrowing (via safe assets) and investing in FDI abroad. China is doing the opposite
Macroeconomics in the Global Economy
Session 3. Summary
Financial transactions and commercial transactions are linked by the balance of payments identity.
Current Account balance must match Capital and Financial Account balance.
In an open economy Saving – Investment = Current Accountbalance. The interest rate is determined by the rest of the world.
Saving Glut caused both a decrease in interest rates and an explosion of global imbalances. Both phenomena are related.
Macroeconomics in the Global Economy
v Example:
Nikon (a Japanese company) sells to a US customer a digital camera for $1000. Suppose the buyer pays by depositing a check to the US-based account of Nikon. Then the transaction is recorded in Japan’s Balance of Payments as:
Export of goods for 1000 USD Purchase of a foreign asset 1000 USD
CURRENT ACCOUNT: +1000 CAPITAL and FIN. ACCOUNT: -1000
Appendix: Balance of payments: Examples
Macroeconomics in the Global Economy
v Example 2:
A rich Singaporean decides to buy a chateau in France. To get the necessary 10 million Euros for the purchase, she goes to the Monetary Authority of Singapore and buys the Euros by paying 20 million SGD. After the purchase of the chateau, the transaction will be recorded in Singapore’s balance of Payments as follows:
CAPITAL and FIN. ACCOUNT: 0
Purchase of a foreign asset -20M SGDDecrease in official reserves +20M SGD
CURRENT ACCOUNT: 0
Appendix: Balance of payments: Examples
