Open Economy Macro: International Macro International Economics: International Trade: flows of real stuff (exports, imports, FDI, migration,..) International Macro: flows of money and assets (current account, exchange rates, sovereign debt,...) International Political Economy: international decision making (voting, negotiations, wars,...) Professor Dr. Holger Strulik Open Economy Macro 1 / 36
Main Textbook: Schmidt-Grohe, Uribe, Woodford (2016): International Macro Download: http://www.columbia.edu/~mu2166/uim/index.html Supplementary Textbook: Obstfeld and Rogoff (1996): Foundations of International Macro, MIT Press. Slides (and other stuff): http://www.holger-strulik.org/oem/oem_material.php Professor Dr. Holger Strulik Open Economy Macro 2 / 36
Tentative Outline of the Course: 1 The current account and global imbalances 2 A theory of current account determination 3 Current account determination in a production economy 4 External adjustments in small and large economies 5 Twin deficits: Fiscal and current account imbalances 6 International capital market integration 7 Financial development and global imbalances 8 Capital account liberalization and growth 9 Determinants of the real exchange rate 10 Aggregate demand shocks and real exchange rates 11 Exchange rate policy and unemployment 12 The European balance of payment crisis 13 Sovereign debt 14 More on debt 15 Monetary policy and exchange rate determination Professor Dr. Holger Strulik Open Economy Macro 3 / 36
1. The Current Account and Global Imbalances All international transactions of a country are recorded in the balance of payments 2 parts: Current account (CA): net exports of goods and services plus international payments of income Financial account (FA): sales of assets to foreigners minus purchases of assets from foreigners standards of book-keeping (double-entry): fundamental balance of payments identity: CA FA Professor Dr. Holger Strulik Open Economy Macro 4 / 36
The Current Account. CA consists of: Trade balance (TB) merchandize trade balance plus services balance Income Balance (IB): net investment income (NII) plus net international compensation of employees Net unilateral transfers (UT): remittances, grants, aid Thus: Capital account (capital transfers due to debt forgiveness, migration, international insurance etc.): This component is ignored in the exposition because it is not substantial for most countries CA TB + IB + UT Professor Dr. Holger Strulik Open Economy Macro 5 / 36
Financial account: (plus) Net increase of foreign-owned assets from home: foreign purchases and sales of home securities; home borrowing of foreign banks; foreign direct investment at home (minus) Net increase of home-owned assets from abroad: home purchases and sales of foreign securities; home bank lending to foreigners; home direct investment abroad Professor Dr. Holger Strulik Open Economy Macro 6 / 36
The U.S. Balance-of-Payments Accounts in 2014 Billions Percentage Item of dollars of GDP Current Account -389.5-2.2 Trade Balance -508.3-2.9 Balance on Goods -741.5-4.3 Balance on Services 233.1 1.3 Income Balance 238.0 1.4 Net Investment Income 247.4 1.4 Compensation of Employees -9.4-0.1 Net Unilateral Transfers -119.2-0.7 Private Transfers -104.9-0.6 U.S. Government Transfers -14.3-0.1 Source: Bureau of Economic Analysis, http://www.bea.gov. Professor Dr. Holger Strulik Open Economy Macro 7 / 36
and for us... Source: Bundesbank: https://www.bundesbank.de/navigation/de/ Statistiken/Aussenwirtschaft/Zahlungsbilanz/zahlungsbilanz.html Professor Dr. Holger Strulik Open Economy Macro 8 / 36
Mio Leistungsbilanz Warenhandel (fob/fob) 1) Dienstleistungen (fob/fob) 3) Primäreinkommen Sekundäreinkommen darunter: Ergänzungen zum Außenhandel, Ausfuhr Einfuhr Saldo Saldo 2) Einnahmen Ausgaben Saldo Einnahmen Ausgaben Saldo Einnahmen Ausgaben Saldo Zeit 1 2 3 4 5 6 7 8 9 10 11 12 13 2002 611 848 469 745 + 142 103 + 6 008 107 806 153 245 45 440 107 664 133 259 25 596 41 522 70 935 29 413 2003 619 677 489 656 + 130 021 2 105 103 853 152 560 48 708 111 694 130 614 18 920 50 266 81 313 31 047 2004 686 081 532 915 + 153 166 6 859 118 814 157 527 38 713 142 348 125 488 + 16 860 38 668 68 776 30 109 2005 739 949 582 940 + 157 010 6 068 128 397 168 996 40 600 167 339 146 434 + 20 905 42 036 73 621 31 585 2006 841 482 680 035 + 161 447 4 205 144 301 178 942 34 641 208 671 167 217 + 41 453 39 489 71 789 32 300 2007 926 777 724 788 + 201 989 922 154 155 189 036 34 881 245 378 209 045 + 36 332 42 075 75 879 33 804 2008 948 735 764 214 + 184 521 3 586 164 590 196 057 31 467 197 571 172 846 + 24 724 44 319 78 779 34 461 2009 770 389 629 222 + 141 167 6 064 159 648 179 296 19 648 183 228 128 471 + 54 757 41 199 76 242 35 043 2010 918 340 757 194 + 161 146 5 892 171 743 198 783 27 041 199 738 149 073 + 50 665 42 328 82 209 39 880 2011 1 030 114 866 687 + 163 426 8 900 181 374 212 948 31 574 219 465 151 230 + 68 235 50 779 85 788 35 010 2012 1 071 431 871 031 + 200 401 10 518 196 509 229 284 32 775 203 734 138 876 + 64 858 52 747 91 641 38 894 2013 1 080 212 867 550 + 212 662 3 663 205 628 247 004 41 376 190 437 128 468 + 61 969 60 095 103 734 43 639 2014 1 115 751 887 390 + 228 361 5 873 224 463 249 786 25 323 189 380 133 204 + 56 177 61 951 103 139 41 188 2015 1 179 210 918 028 + 261 182 2 668 246 160 264 762 18 602 192 837 135 467 + 57 370 65 207 105 193 39 987 2016 1 193 306 923 506 + 269 800 1 434 254 300 275 518 21 218 188 852 136 716 + 52 136 64 880 104 881 40 001 Professor Dr. Holger Strulik Open Economy Macro 9 / 36
Kapitalbilanz (Zunahme an Nettoauslandsvermögen: + / Abnahme an Nettoauslandsvermögen: -) Saldo des übrigen Kapitalverkehrs darunter: Saldo Saldo der der Finanz- Langfristige Kurzfristige statistisch Saldo der derivate und Kredite der Kredite der nicht Saldo der Vermögens- Saldo der Saldo der Mitarbeiter- Monetären Monetären aufglieder- Leistungs- änderungs- Direkt- Wertpapier- aktien- Finanz- Finanz- Währungs- Saldo der baren Transbilanz bilanz 4) investitionen anlagen optionen Insgesamt institute 5) 6) institute 6) 7) reserven Kapitalbilanz aktionen 8) 14 15 16 17 18 19 20 21 22 23 24 Zeit + 41 655 4 010 36 743 66 945 + 496 + 113 294 + 33 790 224 2 065 + 8 038 29 606 2002 + 31 347 + 5 920 23 753 54 391 + 1 513 + 124 635 + 32 555 + 24 947 445 + 47 559 + 10 292 2003 + 101 205 119 + 24 567 15 058 + 6 578 + 98 217 6 300 + 31 771 1 470 + 112 834 + 11 748 2004 + 105 730 2 334 + 21 786 + 29 865 + 7 961 + 39 006 + 69 870 8 939 2 182 + 96 436 6 960 2005 + 135 959 1 328 + 48 646 + 18 328 + 4 504 + 88 598 + 71 490 + 26 068 2 934 + 157 142 + 22 511 2006 + 169 636 1 597 + 65 105 153 824 + 83 570 + 187 365 + 96 582 + 53 695 + 953 + 183 169 + 15 130 2007 + 143 318 893 + 43 268 31 933 + 27 651 + 80 343 + 143 998 28 982 + 2 008 + 121 336 21 088 2008 + 141 233 1 858 + 32 203 + 85 437 6 843 + 10 248 25 880 30 496 + 8 648 + 129 693 9 683 2009 + 144 890 + 1 219 + 45 158 + 112 835 + 13 539 80 388 77 680 12 691 + 1 613 + 92 757 53 351 2010 + 165 078 + 419 + 7 492 34 315 + 28 591 + 116 254 + 12 911 12 120 + 2 836 + 120 857 44 639 2011 + 193 590 413 + 26 449 + 51 786 + 24 138 + 47 748 47 821 + 8 932 + 1 297 + 151 417 41 759 2012 + 189 616 563 + 20 107 + 158 100 + 23 894 + 22 421 24 946 4 699 + 838 + 225 360 + 36 307 2013 + 218 026 + 2 355 + 72 030 + 133 496 + 31 896 + 3 772 + 4 407 12 308 2 564 + 238 630 + 18 248 2014 + 259 963 635 + 54 073 + 196 946 + 26 202 40 406 + 472 5 245 2 213 + 234 603 24 725 2015 + 260 716 + 1 112 + 22 627 + 207 911 + 32 792 21 430 + 21 521 + 10 601 + 1 686 + 243 586 18 242 2016 Professor Dr. Holger Strulik Open Economy Macro 10 / 36
And in % of GDP: GDP 2015: 3460 billion trade balance 269-21= 248 billion trade balance surplus: 7.1 % percent of GDP current account surplus: 7.5 % percent of GDP Germany is Export-Weltmeister is to be Export-Weltmeister a desirable goal? in terms of GDP many other countries have a higher trade balance surplus... Professor Dr. Holger Strulik Open Economy Macro 11 / 36
country current account in % of GDP Professor Dr. Holger Strulik Open Economy Macro 12 / 36
15 TB and CA in 2005 for selected countries 10 5 China 100 CA/GDP 0 Philippines Mex Arg Ire 5 USA 10 45 o 15 15 10 5 0 5 10 15 100 TB/GDP Professor Dr. Holger Strulik Open Economy Macro 13 / 36
Rule of thumb: CA TB however, there are many exceptions... Trade Balance and Current Account as Percentages of GDP in 2005 for Selected Countries Country TB/GDP CA/GDP Argentina 5.9 2.9 Ireland 11.7-3.5 Philippines -5.6 1.9 United States -3.4-3.0 Argentina: Trade balance surplus but negative income balance due to interest payments on foreign debt. Ireland: Large trade balance surplus but even larger income balance deficit (due to huge capital inflows in the 1980s and 1990s Ireland has to pay income on its large external obligations). Philippines: Trade balance deficit but large positive UT due to remittances from abroad Professor Dr. Holger Strulik Open Economy Macro 14 / 36
Long-run trends old stylized fact: the CA is on average balanced new phenomenon (since the 80 s) some countries run always deficits, others always surpluses these seem to get larger over time Global imbalances... Professor Dr. Holger Strulik Open Economy Macro 15 / 36
Professor Dr. Holger Strulik Open Economy Macro 16 / 36
Professor Dr. Holger Strulik Open Economy Macro 17 / 36
Source: Eurostat Professor Dr. Holger Strulik Open Economy Macro 18 / 36
Net International Investment Position (NIIP) aka net foreign asset position The NIIP is a country s net foreign wealth is the difference between foreign asset holdings by citizens of the home country and home asset holdings by foreigners reflects a country s net borrowing needs (whether a country is a debtor or a creditor) Thus NIIP = CA + VC, VC: valuation changes, e.g. due to currency appreciations/depreciations Professor Dr. Holger Strulik Open Economy Macro 19 / 36
Professor Dr. Holger Strulik Open Economy Macro 20 / 36
Valuation Changes and the NIIP. depreciation of the Dollar in the 2000s foreign stock markets outperformed the US stock market in 2002 to 2007 (return of 190% compared to 90%) hypothetical NIIP 2014 = NIIP 1976 + CA 1977 + CA 1978 +... + CA 2014 hypothetical NIIP: $ 9.9 trillion (57% of GDP) actual NIIP: $ 6.9 trillion (40 % of GDP) Professor Dr. Holger Strulik Open Economy Macro 21 / 36
The U.S. NIIP and the Hypothetical NIIP Since 1976 (billions of dollars) 2000 0 2000 Actual NIIP Billions of dollars 4000 Hypothetical NIIP 6000 8000 10000 1980 1985 1990 1995 2000 2005 2010 Year In 2015 foreign investors owned 20% of US stocks and 43% of US bonds. Professor Dr. Holger Strulik Open Economy Macro 22 / 36
Chapter 1. Introduction The Balance of Payments Cumulative Current Account Balances Around the World: 1980-2012, billions of U.S. dollars 2012, billions of U.S. dollars. Professor Dr. Holger Strulik Open Economy Macro 23 / 36
Big lenders: Oil exporting countries: Russia, Middle East, Norway, Venezuela China, Japan, Germany Big borrowers: USA, Southern Europe, Turkey, Brazil, Great Britain, Australia Are these global imbalances sustainable? What happens if the answer is negative? Professor Dr. Holger Strulik Open Economy Macro 24 / 36
Professor Dr. Holger Strulik Open Economy Macro 25 / 36
Professor Dr. Holger Strulik Open Economy Macro 26 / 36
Excursion: The Negative NIIP and-positive NII Paradox. USA has a negative NIIP. It is a debtor as a consequence, we would expect that net investment income (NII) is also negative Yet... Professor Dr. Holger Strulik Open Economy Macro 27 / 36
300 Negative NIIP: A Paradox? 6000 200 4000 US Net Investment Income, $bn 100 0 100 200 2000 0 2000 4000 US NIIP, $bn 300 6000 400 1980 1985 1990 1995 2000 2005 2010 Year 8000 Professor Dr. Holger Strulik Open Economy Macro 28 / 36
Potential explanation 1: Dark Matter : Underestimation of US net foreign asset holdings entrepreneurial capital and brand capital not measured accurately; however, the associated income might be accurately measured Example: McDonald s branch in Moscow. The brand name generates extra income on top of the amount of dollars invested Professor Dr. Holger Strulik Open Economy Macro 29 / 36
How large would Dark Matter be? In this case true NIIP (TNIIP): where DM is Dark Matter. Then TNIIP = NIIP + DM, TNIIP = NII /r. From Table slide 7: NII= 247 billion $. For an interest rate r of 5% this would be TNIIP = 0.247/0.05 = 4.9 trillion $. The measured NIIP is -5.3 trillion Dark Matter 10.2 trillion $!!! Professor Dr. Holger Strulik Open Economy Macro 30 / 36
Potential Explanation 2: Differential Rate of Return. suppose: rate of return of foreign investors on US assets is lower than the rate of return of US investors on foreign assets e.g.: foreigners hold low risk assets (US Treasury Bills), while US investors hold more risky foreign stocks with relatively higher returns Thus NII = r A A r L L, A:gross assets; L: gross liabilities In 2014: NII: $ 0.25 trillion; L = 31.6 trillion $; A = 24.7 trillion $. Take r L = 0.125%, the interest rate on one-year Treasury securities r A = 0.84%, a spread (risk premium) of about 0.7% empirically more plausible than 10.2 trillion $ of Dark Matter. End of Excursion Professor Dr. Holger Strulik Open Economy Macro 31 / 36
Current Account Sustainability 1. Is a Perpetual TB Deficit Possible? Then Suppose: 2 periods B 1 : NIIP of the home country at the end of period 1, NII 1 = rb 0. Suppose: no international labor income, no unilateral transfers, no value changes Eliminate B 1 : CA 1 = B 1 B 0 = rb 0 + TB 1 B 1 = (1 + r)b 0 + TB 1 B 2 = (1 + r)b 1 + TB 2 B 2 = (1 + r)[(1 + r)b 0 + TB 1 ] + TB 2 (1 + r)b 0 = B 2 1 + r TB 1 TB 2 1 + r Professor Dr. Holger Strulik Open Economy Macro 32 / 36
No-Ponzi-Game Condition: B 2 0, End (Transversality) Condition: B 2 0 This leads to B 2 = 0 and (1 + r)b 0 = TB 1 TB2 1 + r Initial NIIP must equal the present value of future trade deficits US is net foreign debtor. it will have to run a trade surplus at some point in the future a country can run a perpetual TB deficit if its initial NIIP is positive. Professor Dr. Holger Strulik Open Economy Macro 33 / 36
2. Is a Perpetual CA Deficit Possible? Recall: B 1 B 0 = CA 1 and B 2 B 1 = CA 2. Eliminating B 1 and using B 2 = 0, we get B 2 (CA 1 + B 0 ) = CA 2 B 0 = CA 1 CA 2 Initial NIIP must equal the sum of its CA deficits Negative initial NIIP has to be repaid by at least one positive future CA surplus such that (CA 1 + CA 2 > 0)] a country can run a perpetual CA deficit if its initial NIIP is positive. This result does not necessarily hold for infinite horizons: sufficient: perpetual CA deficits possible with non-positive initial NIIP. Foreign debt has to grow at a rate less than the interest rate. This requires the TB to be positive and to increases over time (for partial debt repayments). This in turns requires a growing economy, otherwise the required TB surplus would exceed its GDP at some point. Professor Dr. Holger Strulik Open Economy Macro 34 / 36
Useful Accounting Identities: Savings, Investment, and the Current Account. Recall Thus CA t = Bt Bt 1 (in the absence of valuation changes), CA t = TB t + rbt 1 = X t IM t + rbt 1, Q t = C t + I t + G t + X t IM t. TB t = Q t C t I t G t CA t = rb t 1 + Q t C t I t G t. in which Q t is GDP and Y t = Q t + rbt 1 is national income (GNP). This provides CA t = Y t C t I t G t. (1) Professor Dr. Holger Strulik Open Economy Macro 35 / 36
Define National Savings: S t = Y t C t G t. Thus CA t = S t I t Define Domestic Absorption: A t = C t + I t + G t. Thus CA t = Y t A t To summarize, we have 4 alternative expressions for the current account: CA t = Bt Bt 1 CA t = rbt 1 + TB CA t = S t I t CA t = Y t A t Professor Dr. Holger Strulik Open Economy Macro 36 / 36