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National accounting in an indebted open economy. Gianni Vaggi April 2014. The national accounting in an indebted open economy. Suppose D 0 = 100 to be repaid in 10 years and i = 5%, each year: iD interest payments = 5 Δ D principal repayment = 10 - PowerPoint PPT Presentation

Transcript of National accounting in an indebted open economy

• National accounting in an indebted open economy

Gianni VaggiApril 2014

• The national accounting in an indebted open economySuppose D0 = 100 to be repaid in 10 years and i = 5%,each year:iD interest payments = 5 D principal repayment = 10

iD + D = DSDebt Service

• The national accounting in an indebted open economyRemember: FA = NCF = Net Capital Flows = (Inflows Outflows)FA = [(Inflows - Other Outflows) -D] = dD/dtD
• The national accounting in an indebted open economyCA+FA = 0Suppose an indebted economy where there are only foreign debt related flows: (Inflows - Other Outflows) = 0and no other item in NPI and NSI other than iD [(X-M) - iD] - D = 0(X-M) = iD + D = DSTake the example: DS = 5 +10 = 15

(X-M) - iD = D

• The national accounting in an indebted open economyIF the trade balance is 15 and exactly covers the debt service, then the overall debt decreases by D = D0 - D1 , according to the original scheduled payments or:-D = 90 -100 = -10 = -dD/dtIF the trade balance is 5 and covers interests only, then D = 0 and the overall debt does not change: dD/dt=0IF the trade balance is less than 5 and, then the overall debt increases:dD/dt=>0

• The Current Account BalanceNow suppose there are other financial flows in the CAIn the BoP the Current account balance (CA) is the sum of three items:

Trade balance (X-M)Net income transfers (interest payments, dividends, etc.;)= Net Primary Income = NPINet unilateral transfers (remittances, international aid, etc.)= Net Secondary Income = NSI

• The national accounting in an indebted open economyNet primary income: Interests on foreign debtDividends (on portfolio investments);Earnings of FDIs, profit repatriationRents on land and natural resources;Compensation of employees (cross-border workers).Net secondary income: Personal transfers (i.e. remittances);Current) International cooperation,ODA

• The national accounting in an indebted open economyConsider the following flows:-iD are outflows in NPI = -5

Compensation of employees are often included in remittances

NSI includes-remittances-international aid , ODA

• The national accounting in an indebted open economyRemember:[(X-M) + NPI + NSI] = CA Current Account Balanceand CA + FA = 0

[(X-M) - iD + NSI] + (-D) = 0

[(X-M) + NSI] = iD + D = DS = 15

• Debt sustainability - 1D = overall foreign debtY = GDPgn = (dY/dt)/Y is the nominal growth rate

Thresholdsd(D/Y)/dt < 0

The latter: Domar 1944

• Debt sustainability - 2By total differentiation of D/Y:d(D/Y)/dt = [ (dD/dt)*Y - (dY/dt)*D ]/ Y2 = (dD/dt)Y - [ (dY/dt)/Y ] * (D/Y) = (1/Y) [dD/dt - gn * D ]

But dD/dt = [inD - (X M)]

• Debt sustainability - 3i = (in - dp/dt) and g = (gn - dp/dt)dp/dt inflation rate on debt

d(D/Y)/dt = (i - g)D/Y - (X - M)/Y

i, g are the real interest rate and the GDP growth rate

d(D/Y)/dt = inD/Y - gnD/Y - (X - M)/Y

• Debt sustainability - 4But there are also other financial flows:Current Account (CA)= [(X-M) + NPI + NSI ]

NICA = [CA iD] = Non-Interest Current Account NICA = [CA iD] = [(X-M) + NPI + NSI] - iD

NICA largely depends on the trade balance, but not only.

• Debt sustainability - 5The correct sustainability formula is

d(D/Y)/dt = (i - g)D/Y - NICA/Y

• Debt sustainability 6- and national public debtNICA is the equivalent for foreign debt of the concept of Primary surplus (net of interests) for domestic(public) debt(T G) = Primary surplus [(T G) iD] (