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					ISET 2008 Yerevan Spring School
    Macroeconomic Module
       Lecture 3. April 12, 2008


         Robert TCHAIDZE
                 On Saturday …
• Potential output – signals long-run growth
  and short-run inflationary pressures.
• Role of fiscal policy.
• Assessment of fiscal policy – revenues,
  expenditures, budget deficit.
• Different ways of financing.



April 12, 2008      MACRO FRAMEWORK            2
                 Quasi-Fiscal Activities
• Quasi-fiscal activities are allocation of
  public resources not through the budget.
• Examples: loans from central bank to
  banks; energy sector.
     – How big is government?
     – Contingent liabilities.
     – Since it is like a tax or a subsidy it may create
       undesirable redistributive effects.

April 12, 2008          MACRO FRAMEWORK                    3
          QFA in the Energy Sector
• Used to be a big problem in FSU.
     – Ukraine: estimated to be 5.2% of GDP in 2000.
• Quasi-Fiscal Costs
     – Selling at rates below cost recovery;
     – Tolerating non-payments;
     – Output losses resulting from underinvestment.
• Quasi-Fiscal Financing
     – Payment and tax arrears;
     – Underinvestment.

April 12, 2008          MACRO FRAMEWORK                4
 Current Account, Saving, and Investment

• GDP = C + I + G + X – M

• Gross national disposable income
  – Net factor income – interest payments and
    remittances.
  – Net current transfers from abroad.

•   GNDI = C + I + G + X – M + Yf + TRf
•   GNDI – C – G – I = CAB
•   S – I = CAB
•   (Sp – Ip) + (Sg – Ig) = CAB

April 12, 2008       MACRO FRAMEWORK            5
     CAB as Saving-Investment Balance
• The current account reflects decisions by
  people about how much to consume now
  and how much to save in order to
  consume later.
     – Save while working to spend when retire;
     – Save during unusually good years to spend
       during unusually bad years.
• In open economies there is an opportunity
  to invest own saving in other countries that
  may offer better returns.
April 12, 2008      MACRO FRAMEWORK                6
  CA Deficits/Surpluses Arise When
• Temporary negative external shocks;
• Short-run macroeconomic imbalances
  (e.g. overheating, government spending);
• Population aging;
• The deletion of natural resources;
• Need for development finance: low capital
  stock may imply in higher return to capital,
  attract more investment.
April 12, 2008   MACRO FRAMEWORK                 7
                 Balance of Payment
• BOP summarizes all transactions between the
  domestic economy and the rest of the world:
  trade in goods and services, and financial
  instruments.
• Transactions that involve export or import of
  goods or services enter the current account.
• Transactions that involve purchase or sale of
  assets (physical or financial) enter the capital
  and financial account.
• There is a separate line for changes in
  international reserves.
April 12, 2008        MACRO FRAMEWORK                8
         Double Accounting in BOP
• Every transaction is written twice – once as a
  positive entry, once as a negative entry.
  Hence, the sum of all accounts – current;
  capital; financial; reserves – is always zero.
• Whenever something is exported – a good
  (export) or a financial instrument (borrowing)
  – the entry is with a plus.
• Whenever something is imported – a good
  (export) or a financial instrument (borrowing)
  – the entry is with a minus.

April 12, 2008    MACRO FRAMEWORK                  9
         Double Accounting in BOP
• When a resident purchases a foreign good
  and pays with a check:
     – There is debit in the current account (import of
       a good)
     – There is credit in the financial account (export
       of a financial asset – a claim on a domestic
       bank)




April 12, 2008        MACRO FRAMEWORK                10
         Double Accounting in BOP
• When a resident purchases a meal when
  traveling abroad and pays with a credit
  card:
     – Debit in the current account (import of a
       service)
     – Credit in the financial account (export of a
       financial asset – a claim on a credit company)




April 12, 2008       MACRO FRAMEWORK                11
         Double Accounting in BOP
• When a resident purchases a share in a
  foreign company, paying with cash:
     – Debit in the financial account (import of a
       financial asset)
     – Credit in the financial account (export of a
       financial asset – a claim on the domestic
       economy)




April 12, 2008        MACRO FRAMEWORK                 12
        Financing Current Account
• Used to be called (and still is in textbooks)
  capital account. Under new accounting
  terminology, most of the transactions fall into
  financial account.

• Capital Account
• Financial Account
     – Foreign Direct Investment
     – Portfolio Investment
     – Other Investment
• International reserves
April 12, 2008         MACRO FRAMEWORK              13
                         FDI
• Foreign Direct Investment
     – Purchase of a substantial and long-lasting
       interest in a company resident in another
       country, including management and other
       control rights.
     – The least volatile form of capital flows.




April 12, 2008       MACRO FRAMEWORK                14
                 Portfolio Investment
• Portfolio investment (equity, bonds, and
  other securities)
     – Purchase of equity/shares and debt securities
       that do not give substantial control rights.
     – Influenced by relative rates of return: interest
       rate differentials; transaction costs; expected
       exchange rate changes; risk premium.




April 12, 2008         MACRO FRAMEWORK                15
                   Also …
• Other investment: trade credits, bank loans,
  leases…
• Capital Account – large and infrequent
  transfers that generate changes in the stock of
  the country’s financial or real assets.
• International reserves usually controlled by the
  monetary authorities: foreign currency,
  deposits, and securities; gold; Special Drawing
  Rights (SDRs) and reserve position in the IMF.

April 12, 2008     MACRO FRAMEWORK               16
                 External Balance Sheet
• Trade                           • Capital Account
     – Exports                       – Capital transfers
     – Imports                       – Acquisition/disposal of non-
• Services                             produced, non-financial
                                       assets
     – Transportation
     – Travel
                                  • Financial Account
     – Insurance                     – Direct Investment
                                     – Portfolio Investment
• Income                                • Equity
     – Wages                            • Debt
     – Profit                        – Other Investment
     – Investment income (e.g.
       interest)                  • Financing (net
• Current transfers (e.g.           international reserves)
  remittances, grants)            • Errors & Omissions
April 12, 2008            MACRO FRAMEWORK                         17
                 What Attracts Capital?
• Country-specific or “Pull” factors of the recipient
  country
     –   Sovereign Creditworthiness;
     –   Productivity improvement;
     –   Macroeconomic Stability;
     –   Institutional Reforms;
     –   Development of Financial Sector;
     –   Capital account liberalization
• Global or “Push” factors of the investing country
     – Growth in developed countries
     – U.S. interest rate
April 12, 2008           MACRO FRAMEWORK                18
               Non-Debt Creating Flows
• Domestic market size (GDP growth);
• Labor force productivity and costs (ULC);
• Export opportunities (new trade agreements);
• Infrastructure (recent privatization or large
  projects);
• Macroeconomic stability (inflation, exchange rate);
• Institutions (politics, stable & transparent
  regulation).

    April 12, 2008     MACRO FRAMEWORK             19

				
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