EC 201: International Macroeconomics
Lecture 1: Global Imbalances
International Trades Accounts (ITA) / Balance of Payments Accounts: record external positions
of countries
Trade Balance: ITA component measuring difference between exports and imports of goods and
services
Goods Balance=Exports of Goods−Imports of Goods
Service Balance=Exports of Services−Imports of Services
Trade Balance=Goods Balance + Service Balance
- To measure whether the trade balance is significant, we can use the trade deficit / surplus
Trade Balance
Trade Deficit (%)=
GDP
- Before the 1990s, the US had a nominal trade deficit very close to zero, after which it grew
rapidly to US$800bn
This trend is mirrored in other variables measuring economic interconnectedness
- This trend persists even when looking at trade deficit as a percentage of GDP
- A large fraction of this deficit is due to trade with China
Share explained by deficits with China grew from 10% to 50% from 1990 – 2015
- After globalisation began in the 1990s, imbalances have grown
The nominal trade deficit grew consistently in the UK and US, while China and
Germany have had rising trade surpluses
Income Balance: ITA component measuring the difference between incomes paid and received
from the rest of the world, recorded separately for incomes from capital and labour
Net Investment Income (NII): net income from capital (dividends, interest, profits, etc.)
Net International Payments to Employees: net income from labour
Earnings of Expats Abroad – Earningsof Foreign Expats∈ Domestic Country
Income Balance =Net Investment Income
+ Net International Payments ¿ Employees
- In the UK, net primary income was close to zero until 2000, when it began experiencing
large swings (grew to 60bn and then fell to - 40bn)
Globalisation led to divergences in primary income across the world
- Globally, net income grew for Germany and the US, and fell for China and the UK
Net Unilateral Transfers: ITA component measuring difference between gifts received from and
given to the rest of the world, involving both private and public agents
Net Unilateral Transfers=Private Remittances
+Government Transfers
Current Account (CA): Sum of Trade Balance, Income Balance and Net Unilateral Transfers
1
, - If the net current account is negative, ceteris paribus, external debt rises
- Trade balance is the most important driver of the current account for most countries
- But a plot of trade balance as a % of GDP vs current account as a % of GDP has outliers:
In the Philippines, private remittances overcome effect of trade deficit
In Ireland, negative net investment income dominated due to repatriated profits
In Argentina, negative net investment income due to debt repayments dominates
- China doesn’t fully explain US current account deficit, so other surplus countries exist
Japan, Germany, and oil exporters (OPEC, Russia, Norway) financed global deficits
- Overall:
Domestic R est O f W orld
CA +CA =0
- Globalisation led to large global imbalances (countries have run persistent deficits/surpluses)
Net International Investment Position (NIIP): difference between country’s foreign assets and
liabilities [stock variable]
If NIIP > 0, the country is a net creditor
If NIIP < 0, the country has external debt
- US was a net creditor until the 1980s, after which it has grown to the largest net debtor
NIIP in nominal terms and as a % of GDP both falling
- The NIIP can change for two reasons:
Current account deficits or surpluses
Valuation Changes: change in market value of a country’s foreign assets or liabilities
∆ NIIP=CA+Valuation Changes
* Domestic currency appreciations or rises in foreign stock prices improve NIIP, ceteris paribus
- Since the CA of the US has been falling since the 1990s, so has the NIIP
But what about the valuation changes?
- Since 1976, the US has mainly had valuation gains (24 gains versus 14 falls)
Large valuation changes are a recent phenomenon (before 2003, they were ± 1-2%)
- Since 2003, however, they have grown, sometimes to ± 15%
One reason is that gross positions have grown tremendously (assets and liabilities
both over 140% of GDP) so a small change in prices leads to a large valuation change
- If valuation changes were unimportant, plot of current account as a % of GDP against
variation of NIIP as a % of GDP would be on the 45-degree line
This was close to true in the early 1980s, but not remotely true since 2000
- We can construct a hypothetical NIPP without the impact of valuation changes by taking the
NIIP of an initial year and adding all current account balances until the year of interest
2
, By construction, the hypothetical and actual NIIP are both equal to zero in the initial year
- Starting with 1976, without valuation changes, 2014 US NIIP would be -$9.9tr (not -$6.9tr)
SO, valuation change impacts were mainly positive for the US
- For instance, from 2002 – 2007, a depreciation of the dollar led to a lower valuation of
liabilities (which are denominated in dollars) and foreign stock markets outperformed US
Negative-NIIP-Positive-NII Paradox: countries with a negative NIIP (external debt) can receive
investment income from the rest of the world even though NII is interest on NIIP
NII =rNIIP
- Two suggested explanations are (i) dark matter and (ii) return differentials
Dark Matter Hypothesis: NIIP is actually positive but economic agencies fail to account for it all
E.g. intangibles like brand name that are recognized in profits but not in accounts
- TNIIP is the true net international investment position
NII=rTNIIP
- In 2014, the actual net international investment position (NIIP) was - $7tr and the net
international income (NII) was $0.25tr in 2014
- For an r of 5%:
$ 0.25 tr
TNIIP= =$ 5 tr
0.05
Dark Matter =TNIIP−NIIP=$ 5 tr−(−$ 7 tr )=$ 12 tr !
- But this is too unrealistically large to be unaccounted for by either the BEA or IRS
Return Differential Hypothesis: motivated by fact that assets are mostly risky, high-return assets
(e.g. foreign stocks) while liabilities are safer, low-return assets (e.g. T-bills)
NIIP=A−L
A L
NII =r A−r L
- But how big does the difference in returns between assets and liabilities need to be?
- In 2014, the US has a gross asset position of $25tr, a gross liability position of $32tr, r L was
0.13% and NII was $0.25tr
A
0.25=r 25−0.0013× 32
A
r =0.0117
- So, the differential r A −r L only needs to be 1.17 %−0.13 %=1.04 %
This is not unrealistic
- Due to the size of the asset and liability positions, a very small rate of return differentials can
lead to a positive NII despite a negative NIIP
3
Lecture 1: Global Imbalances
International Trades Accounts (ITA) / Balance of Payments Accounts: record external positions
of countries
Trade Balance: ITA component measuring difference between exports and imports of goods and
services
Goods Balance=Exports of Goods−Imports of Goods
Service Balance=Exports of Services−Imports of Services
Trade Balance=Goods Balance + Service Balance
- To measure whether the trade balance is significant, we can use the trade deficit / surplus
Trade Balance
Trade Deficit (%)=
GDP
- Before the 1990s, the US had a nominal trade deficit very close to zero, after which it grew
rapidly to US$800bn
This trend is mirrored in other variables measuring economic interconnectedness
- This trend persists even when looking at trade deficit as a percentage of GDP
- A large fraction of this deficit is due to trade with China
Share explained by deficits with China grew from 10% to 50% from 1990 – 2015
- After globalisation began in the 1990s, imbalances have grown
The nominal trade deficit grew consistently in the UK and US, while China and
Germany have had rising trade surpluses
Income Balance: ITA component measuring the difference between incomes paid and received
from the rest of the world, recorded separately for incomes from capital and labour
Net Investment Income (NII): net income from capital (dividends, interest, profits, etc.)
Net International Payments to Employees: net income from labour
Earnings of Expats Abroad – Earningsof Foreign Expats∈ Domestic Country
Income Balance =Net Investment Income
+ Net International Payments ¿ Employees
- In the UK, net primary income was close to zero until 2000, when it began experiencing
large swings (grew to 60bn and then fell to - 40bn)
Globalisation led to divergences in primary income across the world
- Globally, net income grew for Germany and the US, and fell for China and the UK
Net Unilateral Transfers: ITA component measuring difference between gifts received from and
given to the rest of the world, involving both private and public agents
Net Unilateral Transfers=Private Remittances
+Government Transfers
Current Account (CA): Sum of Trade Balance, Income Balance and Net Unilateral Transfers
1
, - If the net current account is negative, ceteris paribus, external debt rises
- Trade balance is the most important driver of the current account for most countries
- But a plot of trade balance as a % of GDP vs current account as a % of GDP has outliers:
In the Philippines, private remittances overcome effect of trade deficit
In Ireland, negative net investment income dominated due to repatriated profits
In Argentina, negative net investment income due to debt repayments dominates
- China doesn’t fully explain US current account deficit, so other surplus countries exist
Japan, Germany, and oil exporters (OPEC, Russia, Norway) financed global deficits
- Overall:
Domestic R est O f W orld
CA +CA =0
- Globalisation led to large global imbalances (countries have run persistent deficits/surpluses)
Net International Investment Position (NIIP): difference between country’s foreign assets and
liabilities [stock variable]
If NIIP > 0, the country is a net creditor
If NIIP < 0, the country has external debt
- US was a net creditor until the 1980s, after which it has grown to the largest net debtor
NIIP in nominal terms and as a % of GDP both falling
- The NIIP can change for two reasons:
Current account deficits or surpluses
Valuation Changes: change in market value of a country’s foreign assets or liabilities
∆ NIIP=CA+Valuation Changes
* Domestic currency appreciations or rises in foreign stock prices improve NIIP, ceteris paribus
- Since the CA of the US has been falling since the 1990s, so has the NIIP
But what about the valuation changes?
- Since 1976, the US has mainly had valuation gains (24 gains versus 14 falls)
Large valuation changes are a recent phenomenon (before 2003, they were ± 1-2%)
- Since 2003, however, they have grown, sometimes to ± 15%
One reason is that gross positions have grown tremendously (assets and liabilities
both over 140% of GDP) so a small change in prices leads to a large valuation change
- If valuation changes were unimportant, plot of current account as a % of GDP against
variation of NIIP as a % of GDP would be on the 45-degree line
This was close to true in the early 1980s, but not remotely true since 2000
- We can construct a hypothetical NIPP without the impact of valuation changes by taking the
NIIP of an initial year and adding all current account balances until the year of interest
2
, By construction, the hypothetical and actual NIIP are both equal to zero in the initial year
- Starting with 1976, without valuation changes, 2014 US NIIP would be -$9.9tr (not -$6.9tr)
SO, valuation change impacts were mainly positive for the US
- For instance, from 2002 – 2007, a depreciation of the dollar led to a lower valuation of
liabilities (which are denominated in dollars) and foreign stock markets outperformed US
Negative-NIIP-Positive-NII Paradox: countries with a negative NIIP (external debt) can receive
investment income from the rest of the world even though NII is interest on NIIP
NII =rNIIP
- Two suggested explanations are (i) dark matter and (ii) return differentials
Dark Matter Hypothesis: NIIP is actually positive but economic agencies fail to account for it all
E.g. intangibles like brand name that are recognized in profits but not in accounts
- TNIIP is the true net international investment position
NII=rTNIIP
- In 2014, the actual net international investment position (NIIP) was - $7tr and the net
international income (NII) was $0.25tr in 2014
- For an r of 5%:
$ 0.25 tr
TNIIP= =$ 5 tr
0.05
Dark Matter =TNIIP−NIIP=$ 5 tr−(−$ 7 tr )=$ 12 tr !
- But this is too unrealistically large to be unaccounted for by either the BEA or IRS
Return Differential Hypothesis: motivated by fact that assets are mostly risky, high-return assets
(e.g. foreign stocks) while liabilities are safer, low-return assets (e.g. T-bills)
NIIP=A−L
A L
NII =r A−r L
- But how big does the difference in returns between assets and liabilities need to be?
- In 2014, the US has a gross asset position of $25tr, a gross liability position of $32tr, r L was
0.13% and NII was $0.25tr
A
0.25=r 25−0.0013× 32
A
r =0.0117
- So, the differential r A −r L only needs to be 1.17 %−0.13 %=1.04 %
This is not unrealistic
- Due to the size of the asset and liability positions, a very small rate of return differentials can
lead to a positive NII despite a negative NIIP
3
