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ECN 220 (8)


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Ryerson University
ECN 220
Michael Jolly

ECN220 CHAPTER 2 LECTURE NOTES September 11, 2012 Credit and Debit  Credit (positive) items generate inflows of payments from the rest of the world, e.g. payments for goods we export or foreign investment into Canada  Debit (negative) items generate outflows of payments to other countries, e.g. our payments for goods we import or Canadian investment in other countries Current Account 1. Goods and Services  Exports and imports of goods (‘merchandise’)  Exports and imports of services (‘invisibles’) 2. Investment Income 3. Transfers Current Account Balance  Difference between total receipts (credits) and payments (debits) for current account items  If receipts exceed payments there is a “surplus on current account”  If payments exceed receipts there is a “deficit on current account” Capital Account  In older definitions of the balance of payments the ‘capital account’ refers to all international transfer of financial capital  Recent practice includes only a few minor transactions under the heading ‘capital account’ Financial Account  All other transactions between countries involving financial capital are included under the ‘financial account’  For the sake of simplicity, we will ignore the capital account and simply refer to the financial account as including both financial and capital accounts Financial Account Balance  If inflows of foreign financial capital exceed outflows of capital from this country to the rest of the world there is a “surplus on financial account”  If outflows of capital from this country to the rest of the world exceed inflows of foreign capital there is a “deficit on financial account” Relationship between the Current Account and the Financial Account  If there is a current account deficit it will be balanced by a financial account surplus  If there is a current account surplus it was be balanced by a financial account deficit Twin Deficit Hypothesis  The current account deficit and the government budget deficit often move in the same direction  This result is described in the “Twin Deficit Hypothesis”  Recall the National Accounting Identity  YD= GDP = C + I + G + XN Where C is consumption, I is investment, G is government spending on goods and services, and X Ns net exports (i.e. exports minus imports)  If we add investment income and transfers, GDP becomes GNP (Y ) aNd net exports become the current account balance (CA):  YN= GNP = C + I + G + CA  There is also another identity:  YN= C + S p T  Where S iP private sector saving and T is the government tax revenue  YN= C + I + G + CA = C + p + T  Rearranging terms and eliminating C, we get  Sp+ (T-G) = I + CA  The term on the left is equivalent to total saving (private plus government) The term on the right is equivalent to total investment by the economy since the current account balance is always opposite to the financial account balance  Suppose we have a government budget deficit  This mea
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