Transcript Current Account

A Frugal Governed OPEN
Economy
Lecture 23
Dr. Jennifer P. Wissink
©2016 Jennifer P. Wissink, all rights reserved.
November 10, 2016
The Typical Fiscal Response to
the State of the Economy

Basic Policy Tools:
– G = government expenditures
– T = taxes


Typically see expansionary policy (which shifts AD to
right) when at low Y* and little inflation, and just the
opposite with high Y* and troublesome inflation. Same
concerns as with the Fed with stagflation.
Note: Some G and T “policy” is built into the system by
existing laws. The system has built in
– automatic stabilizers
&
– automatic destabilizers
Economic Stability & Fiscal Policy

Automatic stabilizers refer to revenue and
expenditure items in the federal budget that
automatically change with the economy in
such a way as to stabilize Y* or GDP.
– the tax code
– the government safety net, social insurance

Automatic destabilizers refer to revenue
and expenditure items in the federal budget
that automatically change with the economy
in such a way as to destabilize Y* or GDP.
– deficit targeting policy
FIGURE 9.6 The Federal Government Surplus (+) or Deficit (−) as a
Percentage of GDP, 1993 I–2014 IV
MyEconLab Real-time data
Copyright © 2017 Pearson Education, Inc.
9-4
FIGURE 9.7 The Federal Government Debt as a Percentage of
GDP, 1993 I–2014 IV
MyEconLab Real-time data
Copyright © 2017 Pearson Education, Inc.
9-5
Fiscal Policy: Deficit Targeting

The Gramm-Rudman-Hollings
Balanced Budget Act, passed by
the U.S. Congress and signed by
President Reagan in 1985, is a law
that set out to reduce the federal
deficit by $36 billion per year, with
a deficit of zero slated for 1991.

In practice, these targets never
came close to being achieved.
The deficits were:

–
–
–
–
-149,730million in 1987
-155,178million in 1988
-152,639million in 1989
-221,036million in 1990
Fiscal Policy:
The Effects of G on the Deficit

Consider: Government Expenditures (G) and Taxes (T)
– Recall: when G>T  we run a deficit.
– Recall: when G<T  we have a surplus.

Consider: Changes in Y* and the deficit first...
– When Y* or GDP falls (contracts) the deficit tends to rise. WHY?
» Taxable income of households and taxable profits of firms fall.
» Automatic government payments also rise.
– When Y* or GDP rises (expands) the deficit tends to fall. WHY?
» Reverse the argument above...

Now... recall... a decrease in G causes the economy to contract.
– Two effects on the deficit:
» tends to reduce it since you’ve reduced G, but…
» tends to increase it since you will contract the economy

Now... recall... an increase in G causes the economy to expand.
– Two effects on the deficit:
» tends to increase it since you’ve increased G, but…
» tends to decrease it since you will expand the economy
Fiscal Policy:
The Effects of Tax Policy on the Deficit




Very similar to what we just said about G, but more
complicated and harder to predict!
Basically, a decrease in Taxes works “like” an increase
in G.
An increase in Taxes works “like”
a decrease in G.
BIG QUESTIONS WITH TAX POLICY:
– Whose taxes are changing?
– How do these people behave as a consequence?
Fiscal Policy: Consequences for
Economic Stability & Deficit Reduction


Can we “Have our cake and eat it too?”
Congress often has two options:
1. Choose a target deficit and adjust government
spending and taxation to achieve this target.
2. Decide how much to spend and tax regardless of
the consequences on the deficit.
Deficit Targeting as an Automatic Destabilizer


With deficit targeting, the contraction in the economy would be larger.
With deficit targeting, taxes could be rising or government spending declining while the
economy is experiencing a contraction.
So What Do We Do?
 Good
question.
 Options
– spend less
» on what?
– tax more
» on whom?
 Worry
about
– Short run?
– Long run?
– Both?
The Last Wrinkle: International Trade


All economies, regardless of their size, depend to some
extent on other economies and are affected by events
outside their borders.
It’s an OPEN Economy!
– 1970s: imports roughly 7% of US GDP
– 2008-2011: imports roughly 18%, 14%, 16%, 18% of US GDP
» Want to see others?
http://data.worldbank.org/indicator/NE.IMP.GNFS.ZS

The “internationalization” or “globalization” of the U.S.
economy has occurred everywhere:
– in the private and public sectors,
– in input and output markets,
– in business firms and households.
Basics: Trade Surpluses & Deficits
 Trade
Surplus: When a country exports
more than it imports.
 Trade
Deficit: When a country imports
more than it exports.
TABLE 19.1 U.S. Balance of Trade (Exports Minus Imports), 1929–2012
(Billions of Dollars)
Exports Minus Imports
Exports Minus Imports
1929
1991
−27.0
+0.4
1933
1992
−32.8
+0.1
1945
1993
−64.4
−0.8
1955
+0.5
1994
−92.7
1960
1995
−90.7
+4.2
1965
1996
−96.3
+5.6
1970
1997
−101.4
+4.0
1975
1998
−161.8
+16.0
1976
1999
−262.1
−1.6
1977
2000
−382.1
−23.1
1978
2001
−371.0
−25.4
1979
2002
−427.2
−22.5
1980
2003
−504.1
−13.1
1981
2004
−618.7
−12.5
1982
2005
−722.7
−20.0
1983
2006
−769.3
−51.7
1984
2007
−713.1
−102.7
1985
2008
−709.7
−115.2
1986
2009
−388.7
−132.5
1987
−145.0
2010
−511.6
1988
−110.1
2011
−568.1
1989
−87.9
2012
−566.7
1990
−77.6
http://www.census.gov/briefrm/esbr/www/esbr042.html
The United States as a Debtor Nation
A country’s net wealth is the sum of all its past
current account balances.
 Prior to the mid-1970s, the United States was a
creditor nation.
 After the mid-1970s, the United Sates began to
have a negative net wealth position vis-à-vis the
rest of the world.
 A negative net wealth position vis-à-vis the rest of
the world reflects the fact that the United States
spent much more on foreign goods and services
than it earned through the sales of its goods and
services.

The Economic Basis for Trade:
Recall Comparative Advantage

David Ricardo’s theory of comparative
advantage: “specialization and free trade will
benefit all trading partners (real wages will
rise), even those that may be absolutely
more efficient producers.”
i>clicker question: Given the table, suppose Portugal and England are going to trade wine
and cloth with each other. Suppose Portugal is making wine and England cloth. What is
the lowest price (in terms of cloth) we would expect to see barrels of wine selling for?
A.
B.
C.
D.
E.
1/10 a yard of cloth
1/20 a yard of cloth
10 yards of cloth
20 yards of cloth
10 barrels of wine
LABOR (L)
HOURS
REQUIRED
ENGLAND
PORTUGAL
1 yd. cloth
2 hours
1 hour
1 barrel
wine
40 hours
10 hours
From Terms of Trade to Exchange Rates

The ratio at which a country can trade domestic products
for imported products is the terms of trade.
– Was easy with only two goods like guns & butter.
– We looked at internal MOC versus terms of trade.

When we have more than two goods and two countries
and lots of trade  money  currencies  currencies
need to be exchanged  foreign exchange rates.

An exchange rate is the ratio at which two currencies are
traded, or the price of one currency in terms of another.

For any pair of countries, there is a range of exchange
rates that can lead to both countries realizing the gains
from specialization and comparative advantage.
Exchange Rates
and Comparative Advantage

If exchange rates end up in the right ranges, the
free market will drive each country to shift
resources into those sectors in which it enjoys a
comparative advantage.

Only those products in which a country has a
comparative advantage will be competitive in
world markets.
Sources of
Comparative Advantage

The Heckscher-Ohlin (H-O) Theorem is a theory that
explains the existence of a country’s comparative
advantage by its factor endowments.
– Factor endowments: the quantity and quality of labor, land, and
natural resources of a country.
– Eli Heckscher and Bertil Ohlin: economists from Sweden, circa
1933.

According to the H-O theorem, a country has a comparative
advantage in the production of a product if that country is
relatively well endowed with inputs used intensively in the
production of that product.
Sources of
Comparative Advantage

A country with a great deal of good fertile land…
– California & Iowa in agriculture
– Brazil and coffee beans

A country with a large amount of accumulated capital…
– New Jersey in oil refining
– South Korea and passenger cars

A country well-endowed with human capital…
– New York in highly technical financial services
– US and advanced education

Check out this site! Very interesting and oddly fun.
– http://www.worldsrichestcountries.com/top_us_exports.html
Other Suggested Explanations for
Observed Trade Flows
Product differentiation and competitive markets
 Acquired comparative advantage
 Economies of scale and scope

– However, because evidence suggests that economies
of scale are exhausted at relatively small size in most
industries, it seems unlikely that they constitute a
valid explanation of world trade patterns.
 Trading
Environments, Openness of Economy
– Free Trade Policy
– Protectionist Policy
Keeping Track of Trade: Foreign
Exchange & The Balance of Payments
Foreign exchange is simply all currencies
other than the domestic currency of a given
country.
 The balance of payments: it’s the record of
a country’s transactions in goods, services,
and assets with the rest of the world.

– It’s a record of the country’s sources (supply) and
uses (demand) of foreign exchange.
– Note: it’s not a “balance sheet”.
– But: the overall account always balances.
– It’s broken into two pieces
» the Current Account
» the Capital Account
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services

Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
227.0
−133.1
−465.9
In the Current Account…
– Debit items: any transaction that causes the US to loose foreign exchange.
» Imports use up foreign exchange and are a debit (–) item.
– Credit items: any transaction that provides the US with foreign exchange.
» Exports generate foreign exchange and are a credit (+) item on the current account.
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0
TABLE 20.1 United States Balance of Payments, 2011
All transactions that bring foreign exchange into the United States are credited (+) to the current
account; all transactions that cause the United States to lose foreign exchange are debited (−) to
the current account
Current Account
Goods exports
Goods imports
(1) Net export of goods
Exports of services
Imports of services
(2) Net export of services
Billions of dollars
1,497.4
−2,235.8
−738.4
606.0
−427.4
178.6
Income received on investments
744.6
Income payments on investments
−517.6
(3) Net investment income
(4) Net transfer payments
(5) Balance on current account (1 + 2 + 3 + 4)
Capital Account
(6) Change in private U.S. assets abroad (increase is −)
(7) Change in foreign private assets in the United States
(8) Change in U.S. government assets abroad (increase is −)
227.0
−133.1
−465.9
−364.1
789.2
−119.5
(9) Change in foreign government assets in the United States
(10) Balance on capital account (6 + 7 + 8 + 9)
517.4
(11) Net capital account transactions and financial derivatives
37.7
(12) Statistical discrepancy
(13) Balance of payments (5 + 10 + 11 + 12)
211.8
−89.2
0