Pre-lectures - Accounting perspective of a country

 Unlike private companies, states usually do not publish balance sheets but only provide the
values of some of entries. However, they redact comprehensive income statements.
 A country’s real assets are productive factors - which include natural resources, physical capital
(production means and infrastructure) and human capital; technological factors -the
technological knowledge available; governance factors – its cultural, legal, political and
regulatory structures.
 These productive factors, utilized according to the technological expertise and the managerial
structure of the country, generate the productive activity of the country.
 Some financial assets/liabilities like circulating currency or state bonds should be put in the
balance sheet only if held by entities that are not residents of the country. Otherwise, the
debit credit relationship between two national residents would cancel out. In this case they are
not an asset, nor a liability.
 National wealth is the residual entry (liability) that makes the balance sheet balance and is
given by the formula: national wealth = domestic real assets + net foreign assets (NFA).
 If NFA > 0, the country is a net creditor. If < 0, it is a net debtor.
 A country with many natural resources is not necessarily rich if it lacks technological
knowledge and/or the right governance. This can in turn produce a deterioration of real assets,
like physical capital (i.e., workers leaving the country).
 Gross national product (GNP): income generated with assets owned by residents of the
country, even if located abroad. Gross domestic product (GDP): income generated within the
physical boundaries of the country, with ownership of the assets belonging both to residents
and non-residents. GNP - GDP = NFI (net foreign income), the income generated by net foreign
assets (NFA) of the country (we obtain the result because GNP includes income from residents’
assets abroad but excludes non-resident income in the country, while the opposite is true for
GDP).
 National disposable income (NDI) is the amount of income the country can spend without
affecting its NFA. It is given by GNP + net foreign transfers (NFT), cross country money flows
not done in exchange of productive activity (main two: international aid and international
workers remittances).
 GDP can be split into private consumption (C), public consumption (G), total investment (I) and
net exports (NX). C + G + I = total spending of the residents while NX (exports – imports)
measures the net spending of non-residents in goods and services produced within the
country. It tells us whether the country relies on internal or external sources of spending.
 GDP can also be split in primary sector, industry sector and service sector.
 The external income and spending flows of a country are recorded in its balance of payments
(BP). It is an accounting document regularly published by countries containing the economic
transactions with the rest of the world, including financial inflows and outflows.
 The BP is divided into current account (CA) and financial account (FA). The CA records
payments and receipts from other countries, while the FA records financial transactions that
affect the debit/credit position (NFA) of the country.
 CA = NX + NFI + NFT. If CA > 0, the country lends. If < 0, the country borrows. The value of CA is
reflected by a corresponding financial gap with the rest of the world. We therefore have BP =
CA + FA = 0.
 Note that NDI = C + G + I + NX + NFI + NFT = C + G + I + CA. If CA is negative, the country is
spending less than its disposable income, if it is positive then the country is spending more.
 We now introduce national savings (S), defined as NDI – (C+G). Rearranging all the previous
equations we get S – I = CA. This shows the CA as a saving-investment gap: when it is negative,
the country has a shortage of savings over investments that forces it to import capital. When it
is positive, the country has an excess of savings that provide resources to export financing
capital. The CA thus reflects the financial gap with the rest of the world, thus CA = NFA.

 We can now split savings and investment into public and private: S = Sg + Sp; I = Ig + Ip.
Therefore (Sg - Ig) + (Sp – Ip) = CA.
 A negative CA in a certain period is not necessarily a sign of insolvency. What eventually leads
to insolvency is a high debt/income ratio, while a stable debt/income ratio might indicate a
sustainable level of debt.
 Country solvency analysis also looks at the evolution of NFA relative to NDI. If NFA < 0, the
country is a debtor, and the ratio NFA/NDI will have a downward trend that might indicate
insolvency.
 Since debt requires interest payments, it is intrinsically explosive. The cumulative interest
function of debt is D ( 1+ i )t where D is the value of the debt, i is the interest rate and t the
number of time periods for which the interest is paid.
 For a debtor country, offsetting the upward trend of the ratio debt/GDP will be possible only
D ( 1+i )t
with a strong enough GDP growth. Take the equation t where λ is the GDP growth
GDP ( 1+ λ )
ratio: if λ is too low the numerator will increase faster, worsening the ratio and increasing the
risk of insolvency.
 However, a series of CA deficit does not always increase the risk of insolvency. In fact, if the
negative CA (and therefore NFA) was compensated by NDI growth then the ratio would be
stable or even decreasing.
 Since countries are not companies and act according to different rationales and over very long
time frames, we also must ask for which reasons a debtor country is borrowing and who are its
lenders. This might give insight into the expected returns of the debt and in the effort that the
borrowing country might make to service debt (or the willingness of the lenders to keep
lending).

Lecture - 20/09/2021
On notebook.

Lecture - 21/09/2021 SOMEOENE’S NOTES PG 6-8

 Profligate: spending more than its income, borrowing
 Frugal: spending below income, saving
 Financial system failure: using savings from the frugals to lend to the profilgates
It was conventional wisdom, at least before the crisis of 2008, that developed countries would
lend to developing countries because they could afford it. But in general, it was developing
countries that lent to developed ones. The U.S. was the biggest borrower in absolute terms, but
others such as Spain borrowed more with respect to their size.

Lecture - 22/09/2021
On notebook.

Lecture - 23/09/2021 + slides

In this session we will focus on Covid, the legacies of the financial crisis and climate change.
Covid-19
We distinguish two kinds of shocks: exogenous and endogenous. Covid was similar to a natural
disaster, hitting the economy from the outside; it is therefore endogenous. This is different from
the 2008 crisis, which was endogenous as its origin was connected to the economy.
The good thing about exogenous shocks is that since they are external there is no blame to place,
therefore readiness to tackle the problem is higher. The bad thing is that with exogenous shocks it
is more difficult to identify the problem and possible solutions (i.e., we are currently completely
dependent on the health situation, vaccines, virus variants…).
Mitigation trade-off: lower health (and mortality) today vs higher economic costs tomorrow
(lockdown with following recession). Most countries opted for a lockdown, but some as Sweden
did not. A lockdown saves life but sacrifices economic wealth and creates other problems
(depression, lack of attention for other important problems, inequality). In fact, the actual death
toll of the pandemic is estimated to be much higher than just that of covid-deaths. Also, a
lockdown is only a short-term solution as it is highly costly. In the long term, adaptation is needed:
the vaccination campaign.
The economic impact:

 Increased debt
 Weakening household demand
 Business bankruptcies
 Re-emerging financial system weaknesses
As policy response, governments and central banks have taken different actions. The central bank
is a lender of last resort, while the government is a spender/rescuer of last resort. So, the CBs
focused on ensuring liquidity and credit flow at low cost. On the other hand, the government
provides healthcare, state loans, income subsidies, tax deferrals, etc. See slides for more info on
the actions of both CBs and governments.
Inequality
Can be within a country or between different countries.