1. Macroeconomic for Social Negotiators
Open Economy
Gustavo Rinaldi ITC-ILO Consultant
University of Turin - ESCP – Europe
Turin, November 2016

2. European School of Management Italia (C) Copyright 2004
Objective
What is:
The balance of payments
The International Investment Position (IIP or NIIP)
Explaining the spread on sovereign bonds
The aggregated Demand in an open Economy
The Nominal Exchange rate
The Real Exchange Rate

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Balance of payments
measures the payments (flows) that flow between any individual country and all other countries.
The International Investment Positions measures the linked stocks.

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Balance of payments
Current Account
Capital account
Financial account

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Balance of payments
Current Account: its balance indicates a ∆ in the wealth of the nation
The Financial account has the same absolute value of the Current account +Capital account. Errors and omissions exist.

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Current Account
+ export
- import
+services sold to foreigners
- services bought from foreigners
+Net Investment (or capital) Incomes From Abroad
+Net Labor Incomes From Abroad
+Net Transfers
____________________________
Current Account Balance

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Current Account
+ export
- import
+services sold to foreigners
- services bought from foreigners
+Net Investment (or capital) Incomes From Abroad
+Net Labor Incomes From Abroad
+Net Transfers
____________________________
Current Account Balance

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services
Transport
Trading
Insurance
Legal
Medical
Accounting IT
Banking
Restaurant services
Hotelling

12. Net Incomes From Abroad (NIFA)
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Net Incomes From Abroad (NIFA)
Net Labour incomes
Net Capital Incomes
They represent the difference between ….. and …..

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Net Labor Incomes
+ Wages of residents in this country temporarily working abroad
- Wages of residents abroad temporarily working in this country

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Net Capital Incomes
+ Incomes of investors who are resident in this country and earn money with their investments abroad (dividends on shares, capital gains and coupons on bonds, rents on foreign properties, profits from direct participation in foreign firms)
- Incomes of investors who are resident abroad and earn money with their investment in this country

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Net Transfers
+ Presents that residents in this country receive from foreign residents
+ Contributions that international organizations and foreign countries give to this country
- Presents that residents in this country give to foreign residents
- Contributions that this country gives to international organizations and foreign countries

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Current Account
+ export
- import
+services sold to foreigners
- services bought from foreigners
+Net Investment (or capital) Incomes From Abroad
+Net Labor Incomes From Abroad
+Net Transfers (or net secondary income)
____________________________
Current Account Balance

17. CURRENT ACCOUNT / GDP

18. CURRENT ACCOUNT / GDP

20. Current Account / GDP

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Capital Account
+ transfers of capital (debt forgiveness)
+ non financial and non produced assets (land, leases and licenses, and marketing assets such as brands)
+Assets of people leaving or entering the country
____________________________
Capital Account Balance

23. Financial Account = current acc. + capital acc.
European School of Management Italia (C) Copyright 2004
Financial Account = current acc. + capital acc.
Direct Investment (buildings and firms)
Portfolio Investment
Equity
Debt Securities
short term and medium long term.
+ Financial Derivatives
+ Other Investment
Monetary Authorities
General Government
Monetary and Financial Institutions
Other sectors
Reserve assets
ERRORS AND OMISSIONS

24. The International Investment Position (IIP)
European School of Management Italia (C) Copyright 2004
The International Investment Position (IIP)
A statistical statement that presents external assets and liabilities, and net balance of resident sectors at market value.
External assets and liabilities are made up of real and financial assets, either tangible or intangible, held by residents in relation to nonresidents and vice versa.

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28. IMF data

29. The Net International Investment Position is more or less the sum of the current account and capital account of the last years.

36. European School of Management Italia (C) Copyright 2004
The interest paid by sovereign bonds in some periods and in some places depends from some external forces (in the euro zone between 1999 and 2009 the idea that there was European solidarity, more recently the “whatever it takes” or the announcement of purchases of bonds by Draghi).
In other moments it depends on the credit worthiness of the specific sovereign country.
What is the best proxy for the credit worthiness of a sovereign entity?
Deficit/ GDP? NO
Debt/GDP? Not too much.
The IIP or NET IIP (NIIP) is probably the best proxy.

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NIIP
and
interest rare

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Interest rate

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The NIIP in
Permits to predict 76% (78% if we omit the USA) of interest variation in march 2012
Any policy, which worsens the NIIP of a country (e.g. Sale of dividend-making firms or properties to foreigners) risks to increase its interest rate.
The NIIP is influenced by the balance of payments, but what does influence the balance of payments?

40. Open Economy: A New Aggregated Demand
European School of Management Italia (C) Copyright 2004
Open Economy: A New Aggregated Demand
Z ≡ co + c1 (Y-T) + I + G old
Z ≡ co + c1 (Y-T) + I + G + X – IM new
Z ≡ co + c1Y+ I + ( G- c1T) + X – IM …... PRIVATE PUBLIC FOREIGN

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+ X – IM
Trade Balance
Trade Deficit, if < 0
Trade Surplus, if > 0

42. What is the price in international business?
European School of Management Italia (C) Copyright 2004
What is the price in international business?
Price matters
Exchange rate matters

43. Open Economy: A New Aggregated Demand
European School of Management Italia (C) Copyright 2004
Open Economy: A New Aggregated Demand
+ X – IM
when this,
the major component of the Balance Of Payments, diminishes too much,
the country suffers.

44. If residents in foreign countries buy national goods
European School of Management Italia (C) Copyright 2004
If residents in foreign countries buy national goods
The Aggregated Demand of domestic goods increases
Z ≡ co + c1 (Y-T) + I + G + X – IM

45. Open Economy: A new choice
European School of Management Italia (C) Copyright 2004
Open Economy: A new choice
Shall I buy national or foreign goods?

46. Nominale exchange rate
European School of Management Italia (C) Copyright 2004
Nominale exchange rate
A) How much foreign currency should I give to obtain a unit of domestic currency?
You paid $1,48 (29/04/2011) to buy € 1
B) You can also use the reverse, i.e. the price in national currency of a foreign currency
(1/1,48) $ 1 = € 0,68
We just have to be consistent
WE USE A

47. Nominale exchange rate
European School of Management Italia (C) Copyright 2004
Nominale exchange rate
A) How much foreign currency should I give to obtain a unit of domestic currency?
You paid $1,22 (30/12/2014) to buy € 1
B) You can also use the reverse, i.e. the price in national currency of a foreign currency
(1/1,22) $ 1 = € 0,82
We just have to be consistent
WE USE A

48. (Nominal) Exchange rates regimes:
European School of Management Italia (C) Copyright 2004
(Nominal) Exchange rates regimes:
Flexible: authorities (our government and central bank) leave it fluctuate freely
Fixed : Government and/or the central bank fix an exchange rate between national currency and a foreign currency or a basket of foreign currencies and actively defend it
Mixes

49. Cadillac CTS Luxury Sedan
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Cadillac CTS Luxury Sedan

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37,535 $ (nov 2008)

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63,465 $ (apr 2011)

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Alfa Romeo MITO cv

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€ 20, (nov 2008)

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€ 21, (apr 2011)

55. How many Cadillac Sedan was I able to buy with one Alfa MITO in 2008?
European School of Management Italia (C) Copyright 2004
How many Cadillac Sedan was I able to buy with one Alfa MITO in 2008?

56. How many Cadillac Sedan was I able to buy with one Alfa MITO in 2008?
European School of Management Italia (C) Copyright 2004
How many Cadillac Sedan was I able to buy with one Alfa MITO in 2008?
* = , = 0,7
37, ,535

57. How many Cadillac Sedan can I buy with one Alfa MITO, today?
European School of Management Italia (C) Copyright 2004
How many Cadillac Sedan can I buy with one Alfa MITO, today?
1.48 * 21,600 = , = 0,50
63, ,465
We should expect an improvement in Alfa Romeo sales

58. How many Cadillac Sedan can I buy with one Alfa MITO?
European School of Management Italia (C) Copyright 2004
How many Cadillac Sedan can I buy with one Alfa MITO?
It Depends on:
P price Alfa Mito
P* price Cadillac Sedan
E Nominale exchange rate (cost in $ of € 1)‏

59. How many Cadillac Sedan can I buy with one Alfa MITO?
European School of Management Italia (C) Copyright 2004
How many Cadillac Sedan can I buy with one Alfa MITO?
It Depends on:
 = P E P*
R E A L E X C H A N G E R A T E

60. European School of Management Italia (C) Copyright 2004
We are not just interested in these cars, therefore we shall use the price indexes (GDP deflators). The value of GDP deflators depends on the bases that we use; its absolute value is not very important, but its variation is very important

61. Real Exchange Rate Variations
European School of Management Italia (C) Copyright 2004
Real Exchange Rate Variations
Real Appreciation: goods of this country become more expensive
Real Depreciation

62. Real Exchange Rate and Trade Balance
European School of Management Italia (C) Copyright 2004
Real Exchange Rate and Trade Balance
(X – IM) = f (Y,Y*)
The trade balance is a negative function of the real exchange rate and of our GDP, Y, finally, is a positive function of the GDP of our trade partners, Y*)

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Price variation
“Deflation” here indicates how much the 2014 value is smaller than the peak value in the considered period.

65. Real Exchange rate with Germany
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Real Exchange rate with Germany

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Adjustment:
the difference of real exchange rate between peak year and 2014

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69. Real Exchange Rate in 16 years of euro Percentage growth since 1999
GGg

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French Real exchange rate with Germany in 1999
 = 1 * = 1 1

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French Real exchange rate with Germany in 2014
 = 1 * = 1.08
1.17
On average French goods have worsened their relative position with German goods by 8 % in 15 years

72. Open Economy: Investment, Budget surplus and Trade surplus
European School of Management Italia (C) Copyright 2004
Open Economy: Investment, Budget surplus and Trade surplus
Y ≡ C I + G – IM + X …...

73. Open Economy: Investment, Budget surplus and Trade surplus
European School of Management Italia (C) Copyright 2004
Open Economy: Investment, Budget surplus and Trade surplus
Y ≡ C I + G – IM + X …...
Y- C- T ≡ C –C + I + G –T – IM X

74. Open Economy: Investment, Budget surplus and Trade surplus
European School of Management Italia (C) Copyright 2004
Open Economy: Investment, Budget surplus and Trade surplus
Y ≡ C I + G – IM + X …...
Y- C- T ≡ C –C + I + G –T – IM X
Savings ≡ + I + (G –T) + (– IM+X)

75. Open Economy: Investment, Budget surplus and Trade surplus
European School of Management Italia (C) Copyright 2004
Open Economy: Investment, Budget surplus and Trade surplus
Savings ≡ + I + (G –T) + (– IM+X)
+ Private Investment
+ Budget deficit
+ Trade Surplus
= Domestic Private Savings

76. Open Economy: Investment, Budget surplus and Trade surplus
European School of Management Italia (C) Copyright 2004
Open Economy: Investment, Budget surplus and Trade surplus
Domestic Private Savings – Private Investment =
= Budget deficit Trade Surplus

77. The End Thank You!