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National accounting in an indebted open economy

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

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National accounting in an indebted open economy

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  1. National accounting in an indebted open economy Gianni Vaggi April 2014

  2. The national accounting in an indebted open economy Suppose D0 = 100 to be repaid in 10 years and i = 5%, each year: • iD interest payments = 5 • ΔD principal repayment = 10 iD + ΔD = DS Debt Service

  3. The national accounting in an indebted open economy Remember: FA = NCF = Net Capital Flows = (Inflows – Outflows) • FA = [(Inflows - Other Outflows) -ΔD] = dD/dt • ΔD<0 in an indebted economy ΔD is an outflow because debt must be repaid • dD/dt is the change of the debt stock during the year, which depends also on inflows and other outflows in the FA. • CA = [(X-M) + (NPI – iD) + NSI]

  4. The national accounting in an indebted open economy CA+FA = 0 • Suppose an indebted economy where there are only foreign debt related flows: (Inflows - Other Outflows)= 0 • and no other item in NPI and NSI other than –iD [(X-M) - iD] - ΔD = 0 (X-M) = iD+ΔD = DS Take the example: DS= 5 +10 = 15 (X-M) - iD= ΔD

  5. The national accounting in an indebted open economy IF the trade balance is 15 and exactly covers the debt service, then the overall debt decreases by ΔD = D0 - D1 , accordingto the originalscheduledpayments or: -ΔD = 90 -100 = -10 = -dD/dt IF the trade balance is 5 and covers interests only, thenΔD = 0andthe overall debt doesnotchange: dD/dt=0 IF the trade balance is less than 5 and, then the overall debt increases: dD/dt=>0

  6. The Current Account Balance Now suppose there are other financial flows in the CA In 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 = NPI • Net unilateral transfers (remittances, international aid, etc.)=Net Secondary Income = NSI

  7. The national accounting in an indebted open economy • Net primaryincome: • Interestson foreigndebt • Dividends (on portfolio investments); • EarningsofFDIs, profit repatriation • Rents on land and naturalresources; • Compensation of employees (cross-borderworkers). • Net secondaryincome: • Personal transfers (i.e. remittances); • Current) International cooperation,ODA

  8. The national accounting in an indebted open economy Consider the following flows: -iD are outflows in NPI = -5 Compensation of employees are often included in remittances NSI includes -remittances -international aid , ODA

  9. The national accounting in an indebted open economy Remember: [(X-M) + NPI + NSI] = CA Current Account Balance and CA + FA = 0 [(X-M) - iD + NSI] + (-ΔD) = 0 [(X-M) + NSI] = iD + ΔD =DS = 15

  10. Debt sustainability - 1 • D = overall foreign debt • Y = GDP • gn = (dY/dt)/Y is the nominal growth rate • Thresholds • d(D/Y)/dt < 0 The latter: Domar 1944

  11. Debt sustainability - 2 By 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)]

  12. Debt sustainability - 3 d(D/Y)/dt = inD/Y - gnD/Y - (X - M)/Y i = (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

  13. Debt sustainability - 4 Butthere are alsootherfinancialflows: Current Account (CA)= [(X-M) + NPI + NSI ] NICA = [CA – iD] = Non-Interest Current Account NICA = [CA – iD] = [(X-M) + NPI + NSI] - iD NICA largelydepends on the tradebalance, butnotonly.

  14. Debt sustainability - 5 The correctsustainability formula is d(D/Y)/dt = (i - g)D/Y - NICA/Y

  15. Debt sustainability – 6- and national public debt NICA 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] (<0) = overall Fiscal Deficit = FD FD/Y must not exceed 3%

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