Chapter 2 - Current Account Sustainability

What determines if a country can run a perpetual trade balance deficit?

It depends on the country's initial debt position: if net debtor, no; if net creditor, yes.

What is the implication for a country with a negative net international investment position (NIIP)?

It must run a trade balance surplus at some point to service its debt.

What can a country with a positive NIIP do regarding trade deficits?

It can run a perpetual trade deficit financed by the interest generated from its net investments abroad.

What notation is used for trade balance in period t?

TBt

What notation is used for the current account in period t?

CAt

What does Bt represent in the context of international macroeconomics?

Net international investment position at the end of period t.

What is the formula for the change in the NIIP?

∆NIIPt = CAt

What is the relationship between NIIP and current account?

The change in NIIP is equal to the current account, assuming valuation changes are zero.

What does the equation B1 = (1 + r)B0 + TB1 represent?

The country's NIIP at the end of period 1.

What is the sustainability condition derived from the equations?

(1 + r)B0 = -TB1 - TB2/(1 + r)

What does the sustainability condition imply for net debtors?

They must revert their trade balance deficits at some point in the future.

Can a country run a perpetual current account deficit?

It depends on the initial NIIP: positive NIIP allows for it, negative NIIP does not.

What is the identity linking current account to saving and investment?

CAt = St - It

What does the identity CAt = St - It imply?

The country's saving in excess of domestic investment must be allocated to foreign assets.

What is the significance of the current account in macroeconomic aggregates?

It connects to national savings, investment, gross domestic product, and domestic absorption.

What happens to the NIIP if a country runs current account deficits?

The NIIP decreases as the country accumulates more debt or reduces its net foreign assets.

What must be true for a country to run current account deficits in both periods?

The initial NIIP must be positive.

What does the term 'net investment income' refer to?

The return on net foreign assets held by the country's residents.

What is assumed about net unilateral transfers and valuation changes in the analysis?

They are assumed to be zero.

What is the final condition for the NIIP at the end of period 2?

B2 = 0, meaning no assets or debts remain.

What is the formula for a country's aggregate supply of goods and services?

Qt + IMt, where Qt is gross domestic product and IMt is imports.

How is aggregate demand for goods and services calculated?

Ct + Gt + It + Xt, where Ct is private consumption, Gt is government consumption, It is investment, and Xt is exports.

What does the trade balance (TBt) represent?

The difference between exports (Xt) and imports (IMt), calculated as TBt = Xt - IMt.

What is national income (or gross national income, GNP)?

The sum of GDP and net investment income, denoted as GNPt = Qt + rBt−1.

What is the current account (CAt) in relation to national income?

CAt = rBt−1 + TBt, which includes net investment income and the trade balance.

How is national saving (St) defined?

St = Yt − Ct − Gt, which is the difference between national income and consumption.

What is the relationship between current account and saving and investment?

CAt = St − It, indicating that the current account is the gap between saving and investment.

What is domestic absorption (At)?

The sum of private consumption, government consumption, and investment, expressed as At = Ct + Gt + It.

What does the equation CAt = Yt − At signify?

It states that the current account is the gap between national income and domestic absorption.

What is the no-Ponzi-game constraint?

It requires that the limit of BT/(1 + r)T as T approaches infinity must be non-negative, ensuring debt does not grow indefinitely.

What does the transversality condition imply?

It indicates that limT→∞ BT/(1 + r)T = 0, meaning initial net foreign assets must equal the present value of future trade deficits.

What happens if a country is a net debtor (B0 < 0)?

It must run trade surpluses at some point to avoid perpetual trade balance deficits.

How does a net debtor manage debt servicing?

By paying a fraction α of interest obligations via trade surplus, represented as TBt = −αrBt−1.

What is the evolution equation for net foreign assets (Bt)?

Bt = (1 + r)Bt−1 + TBt, showing how net foreign assets change over time.

What does the current account (CAt) imply for a net debtor?

CAt = r(1 − α)Bt−1, indicating that perpetual current account deficits are possible if the economy grows sufficiently.

What is required for perpetual current account deficits to be sustainable?

The economy must grow fast enough to generate required trade surpluses.

What are the four identities that express the current account?

1. CAt = St − It, 2. CAt = Yt − At, 3. CAt = Bt − Bt−1, 4. CAt = rBt−1 + TBt.

What is the next focus in understanding the current account?

Developing a model that explains the determinants of the current account through the behavior of households, firms, governments, and foreign residents.