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Balance of Payments 1 (Chap. 6) (long-run budget constraint (LRBC): a…
Balance of Payments 1 (Chap. 6)
long-run budget constraint (LRBC): a countries ability to adjust its external wealth
prices are flexible
small open economy, cannot influence prices
r* = world real interest rate
all debt carries r*, can lend/borrow an unlimited amt
pays r
on L (liabilities) and is paid r
on A (assets)
W = A - L
NUT = 0, KA = 0, no capital gains on external wealth
if r*W is positive, country is a creditor w/ positive external wealth
if r*W is negative, the country is a debtor with negative external wealth
perpetual loan: interest only loan, only the principal is refinanced per year
sudden stop: borrower country financial account shrinks, and CA deficit shrinks too
smooth consumption in response to a temp. shock to output
foreign reserves: safe assets denominated in foreign currency
sovereign wealth funds: state-owned asset mgmt companies that invest gov savings overseas
LRBC in two cases
closed economy: external borrowing/lending is not possible, trade balance is 0, LRBC is satisfied
open economy: borrowing/lending are possible, trade balance > < 0, LRBC must be verified before satisfied
countries can use W as a buffer to smooth consumption during fluctuation periods
LRBC guarantees that debts are serviced
LRBC can also be put as present value of GDP + PV of initial wealth, must = GNE
TB = 0 in every period in a closed economy , when there is no external trade in goods or assets
CA may be lower in any period where there is high consumption, low output, or high investment
CA can be used as a buffer
large scale investments in poor countries will not accelerate economic growth