1 Current Account

2 Issues and Applications Global capital markets and the current account Debt crisis in developing countries Sovereign risk

3 Balance of Payments Accounting: The Current Account (CA) The current account (CA): measures a country’s trade in currently produced goods and services A negative CA implies that a country is importing more than it is exporting

4 The Current Account around the World

5 The capital and financial account (KFA) measures a country’s trade in financial assets Note that selling assets (e.g. bonds) is equivalent to borrowing and leads to inflow of capital, that is the rest of the world is lending money to us The Capital and Financial Account (KFA)

6 The current account and the capital financial account sum to zero CA+KFA=0 This equation is an Accounting Identity! The Link Between CA and KFA

7 Savings, Investment and the Current Account We know from the Introduction that NX + NFP = CA = S – I Focusing on S – I is equivalent to looking at the CA or the KFA

8 U.S. Current Account Source: US Bureau of Economic Analysis

9 Savings, Investment, and CA

10 U.S. Net International Debt $2.5 trillion is approx. 25% of GDP

11 Sources of Funds for US borrowing What finances US current account deficits: –Sale of US treasury debt –Sale of Corporate debt –Equities

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13 Global Capital Markets Financial markets in New York, London, Frankfurt, Tokyo Each country has savings All these savings enter global financial markets Each country has needs for investment in new plant and equipment The job of the global financial markets is to efficiently allocate the global pool of savings to investment opportunities in different countries

14 Determinants of Savings Aggregate savings is income minus consumption: s = y – c – g Aggregate savings is the sum of private savings and government savings –Govt. Savings are Net Tax Revenue-Govt. expenditure s = s p + s g

15 Determinants of National Saving An increase in the real interest rate causes desired national saving to rise, as the reward to savings rises, see Fig 1. An increase in G causes desired aggregate savings to fall, as overall consumption rises, Fig. 2. An temporary increase in Y causes desired national saving to rise, as households spread the rise in income over current and future consumption, Fig. 3. r S r S r S Fig. 1Fig. 2 Fig. 3 s1s1 s1s1 s2s2 s1s1 s2s2

16 Determination of the Current Account Variables subscripted by w refer to global variables, and those subscripted by arg refer to Argentina.

17 Current Account The global capital markets determine the world real interest rate A country’s savings and investment determines its current account

18 Good Prospects and the Current Account Does a country that experiences a permanent rise in TFP and thereby produces more goods and services respond by on net importing or exporting more goods and services?

19 Growth and the Current Account

20 Recessions and the Current Account Current account deficit falls during recessions and rises during booms

21 Recent U.S. Current Account Current account deficit continues to get larger

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23 Economic Growth OECD refers to Organization of Economic Cooperation and Development. This includes the world’s 24 richest economies. High performance Asian economies (HPAE) are: Singapore, Hong Kong, Thailand, Indonesia, Taiwan, Malaysia, Korea.

24 Education in HPAE Education is the engine of TFP growth Primary is till eighth grade and secondary is high school Source: Alwyn Young, ‘The Tyrrany of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience’, Quarterly Journal of Economics, 1995

25 High Investment

26 Current Account in HPAE

27 CA surplus in China, Germany, and Euro. Why? High savings rate leads to a current account surplus

28 Sovereign Debt, External Debt, and Risk

29 Sovereign debt is debt issued by a government (also public debt)

30 Risk And Sovereign Debt Countries cannot be taken to court if they default on their borrowings This leads to sovereign risk which is reflected in the cost of borrowing Sovereign risk depends on the credibility of not defaulting on the debt Sovereign risk ratings are almost entirely determined by the macroeconomics of the country –Lower Per-Capita income, Higher inflation, and Higher External Debt --- lower the country’s credit rating –Sovereign debt to GDP is a key measure of the sustainability of government debt (although credible governments can sustain high debt-to-GDP levels)

31 Macro-economy and Sovereign Risk Fiscal balance and external balance are relative to GDP. External debt refers to foreign currency debt relative to exports.

32 Sovereign Debt to GDP Ratio by Country

33 External Debt and Default External debt (foreign debt) is debt held by foreigners External debt must be paid off with future current account surpluses (excluding the possibility of default) External debt to GDP is a key indicator of sustainability of external debt External debt to GDP rises –if growth rate of GDP falls –if the cost of external borrowing rises

34 Sovereign Credit Default Swap (CDS) Spreads The buyer of a CDS receives a payment if the credit instrument goes into default

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36 The Lesser-Developed Country (LDC) Debt Crises Prior to 1979, a run-up in commodity prices such as coffee and oil led to an investment boom in many Latin American countries Consequently, many Latin American borrowed heavily and raised the External Debt to GDP ratios Global recession in lowered demand for exports Interest rates on dollar denominated adjustable rate debt rose Debt to exports and debt to GDP rose dramatically In August 1982 Mexico declared a moratorium on interest payments. This led to the debt crises

37 Debt and Current Account 1979 and 1982

38 Current Account Reversals Current account rises (perhaps reverses from deficit to surplus) during a crisis

39 Thailand Malaysia Indonesia Percent Current Account as a share of GDP

40 The Worldwide Real Interest Rate

41 Capital Market Equilibrium for the World Economy

42 Global Capital Markets Variables subscripted by w refer to global variables, and those subscripted by arg refer to Argentina.

43 An Increase in future TFP Expectations of better growth prospects for the future increase investment today Investment determined by (i) real interest rate (ii) future prospects

44 A Decline in Savings A fall in Savings can raise the interest rate and lower investment