Good afternoon. In today’s lecture, we will
talk about how expenditures effect the national
income, and the current account balance of
the countries. So, I will write down the equations
which will tell us, how expenditures of a
country are related to the national income
of a country, and how expenditures affect
the current account balance of the country.
And then we will introduce interdependence
in the model, and then at the end we will
try to figure out, whether a deficit or a
surplus which is generated by the changes
in expenditures or they sustained or or they
negated in the interdependent model.
So, the equations are the following.
These 2 equations, tell us about the impact
of the expenditures on the changes in the
income, and on the current account balance.
So, if you see the first equation; if there
are if there’s a change in the expenditures,
be it the autonomous private expenditures
or policy induced expenditures or the autonomous
changes in net exports, it tends to have an
impact on the incomes; this one upon s plus
m is the open economy multiplier, wherein
s is the marginal propensity to save, and
m is the marginal propensity to import of
the country.
The second equation tells us, that if there’s
change in the autonomous private expenditures
or policy induced expenditures, it tends to
deteriorate your current account balance;
reason being that, if you increase the autonomous
private expenditures and policy induced expenditures,
they tend to have an impact on the incomes.
As the incomes rises, the imports go up; so
there’s a deterioration in the current account
balance; but if there is a switch in expenditures,
in favor of, say the domestic goods from foreign
to domestic goods, dN a goes up and it leads
to an improvement in the in the current account
balance. So, if there’s an increase in dN
a, it will have an impact on the incomes,
but it will also improve the current account
balance.
Now, you can see from here that, if there’s
an improvement in the current account balance,
it has an impact on the incomes. And we are
also saying that, it improves the current
account balance. So, whatever is the impact
on the incomes, and through incomes, there
is a change in the imports; it is still not
able to wipe out the surplus which is created
by the shift of expenditures from from foreign
to domestic goods. So, this is the point that
needs to be understood. And what we need to
probe further is that, if we bring in interdependence
in the model, and if there is a switch in
expenditure from foreign to domestic goods,
will it still lead to an increase in the current
account balance? Or, will there be, still
be balance of payment circlers?
So, think of this in a manner that, say for
example, we introduce another country; we
introduce another country, which is say Japan
and this is U.S or your country is India.
And you introduce the the India’s major
trading partner now as, China; now think of,
what happens if there is a change in the autonomous
private expenditures in India? What we will
see is that, it not only improves the incomes
here, but it also improves the incomes in
the other countries. But on the other hand,
it deteriorates our current account balance.
Because the as the incomes goes up, the imports
go up. But an as a result, this current account
balance is comes to be negative.
Now, when you have Interdependent model, when
you increase expenditures, it increases incomes
in their country; when it increase incomes
in their countries, their imports go up; when
their imports go up, our exports go up; and
yet we will see at the end, that it is not
able to wipe out the deficit which is created
in the current account. So, today we are going
to focus on the Interdependent model. And
finally, we will see whether the changes in
expenditures or the switches are able to wipe
out the deficit or surplus permanently.
And the answer to it is that, it even if you
bring in interdependence, it will not be able
to wipe out the surplus or deficit which is
created, by the shocks which are given in
the in the model; shocks which are given in
the economy. So, if you have to bring in the
Interdependent model, you need to have some
changes in this term dN a; dN a earlier was
dX a minus dM a plus m star dy star, where
you had assumed that the incomes of the foreign
country are constant; and m star is the marginal
propensity to import. Now, in this interdependent
economy, the change is that, you define dN
1 a to be dX 1 a minus dM 1 a; and dN 2 a
to be dX 2 a minus dM 2 a; and dN 2 a is minus
dN 1 a.
So, the equations would become dy 1 1 upon
s 1 plus m 1 dA 1 a plus dA 1 g plus dN 1
a. And you would have m 2 dy 2 divided by
s 1 plus m 1; now, see the how this term as
emerged? Because now, dN 1 a is dX 1 a minus
d 1 dN 1 a and this is m 2 dy 2. So, if you
take it out of the bracket, here out of the
parenthesis, you will get m 2 dy 2 divided
by s 1 plus m 1; similarly, you can define
dy 2 to be equal to 1 upon s 2 plus m 2 dA
2 a plus dA 2 g minus dN 1 a plus m 1 dy 1
divided by s 2 plus m 2. Please recall that,
your dA 2 a or dA a is dI a minus ds a and
dA g, which reflects the fiscal and the monitory
policy of the government is dD minus s r minus
I r dr.
So, the change is, now this change in the
autonomous export term; autonomous change
is in the net exports; now, it is a little
curtailed one; it is dX 1 a minus d 1 dN 1
a and dN 2 a is dX 2 a minus dM 2 a which
is minus dN 1 a. So, now, you have these 2
countries; we are studying the interdependence
models; you have 2 equations in 2 unknowns;
these have to bed to get the values of dy
1 and dy 2. So, I will spend some time on
the board, and then solve these simultaneous
equations.
And see what finally comes out? What impacts
the changes in the in the incomes? And you’ll
find that, it is not only your expenditures;
that is your country’s expenditures. But
their country’s expenditures also having
an impact on your incomes, and then once we
have these figures, we will also get a figure
for or current account balance. So, I will
spend some time doings little bit of algebra.
So, what I am going to do is to replace the
value of dy 2 here with this big big figure.
So, what we get is, that the incomes in your
home country changes, because of the changes
in the expenditures; be it the private expenditures
or the policy induced expenditures; they change
because of the policy induced expenditures,
and the private expenditures in your neighboring
country; in your trading country; in the in
the in the country which is engaging with
you. And if there is a switch in expenditures
from domestic to foreign or foreign to domestic;
say in case of foreign to domestic. And dN
1 a improves; it will tend to increase your
your incomes. Similarly, if you solve for
dy 2, you can always get a value; you can
always get the the the incomes of the second
country.
Now, look at the changes which can happen
in the incomes of your trading partner; the
expenditures which are done there, it tends
to have an impact on the incomes through the
Keynesian multiplier; but your expenditures,
your country’s expenditures also tend to
promote incomes in the other countries. And
any improvement in the net exports, say for
example, if there is a switch in expenditure
from foreign to domestic goods which improves
your net exports, it tends to deteriorate
the net exports there; it tends to have a
negative impact on the incomes. But what you
should be able to understand from from these
two things is that, if dN 1 a increases, it
tends to increase the incomes in your country.
And it leads to a decline in incomes in the
other country; when there is a decline in
incomes in the other country, it leads to
a decline in imports; and when there is a
decline in imports, it leads to a decline
in exports. And yet it is not able to wipe
out the current account surplus that is created
right at the beginning. To further explain
the last point that I just mentioned, I need
to get a figure for the change in net exports
which is dX… So, dN 1, the change in current
account balance dN 1 is equal to dN 1 a plus
m 2 dy 2 minus m 1 dy 1; now, you already
got the values of y 1, dy 1 and dy 2; you
need to substitute here in this equation to
get the value of the current account balance.
So, let us do it. So, in the board, I will
just keep the values of dy 1 and dy 2, and
then for the changes in the current account
balance.
So, dN 1 is equal to dN 1 a plus m 2; instead
of dy 2 I would put that to be… So, dN 1
is dN 1 a plus m 2 dy 2; instead of dy 2,
I have replaced value of dy 2 here. And then
minus m 1 dy 1 which is… Now collect the
common terms, and then see what we get? You
need to focus on this equation, which is the
changes in current account balance in the
first country, in the home country as a function
of the autonomous change in net exports; changes
in expenditures in the other country; the
changes in expenditures in your home country.
So, you see this equation where the changes
in the home countries current account balance
is a is directly related to the expenditures
in your country, that is the home country;
and negatively related to positively related
to the expenditures in the foreign country.
So, what it shows is that, even in the Interdependent
model, if you raise your expenditures, it
will deteriorate the current account balance;
this is happing despite the interdependence
in the model. Please recall the 2 equations
which were 1 upon s plus n dA 1 a plus dA
1 g plus dN 1 a and dN to be equal to s upon
s plus m dN a minus… Even in this model,
where you didn’t have interdependence, expenditures
in your home country, lead to deterioration
in the current account balance; meaning that,
if you raise expenditures, your incomes go
up; when your incomes goes up, your imports
go up; when your imports go up, there is a
deterioration in the current account balance.
This is, when there is no interdependence;
it does not have any impact on the incomes
of the trading partners.
Now, bring in the interdependence; if your
expenditure goes up, their incomes also go
up; when their incomes go up, their imports
go up; when their imports go up, they our
exports go up. And yet it is not able to wipe
out the the negativity in the current account
balance. Do you see this? That if this improves,
if there is an increase in expenditure, let
me repeat it, it leads to a deterioration
in the current account balance. Because the
channel is, when you increase expenditures,
your incomes go up by the value of the multiplier;
your imports go up; so, your current account
deteriorates.
Now, bringing the Interdependent model; when
you increase expenditures, their incomes also
go up. Because dy 2 is not only a function
your expenditures, but their expenditures
also. So, when this goes up, their incomes
go up; their imports go up; our exports go
up. So, there is marginal improvement in the
current account balance. And therefore the
net result is that, there is still, there
is still - underline, current account deficit
in your balance of payments. So, even when
you bring in interdependence, it is not able
to wipe out the current account deficit which
is created by giving a shock to the system;
that is increasing the expenditures in the
economy
So, in today’s lecture, we see that, even
if you have Interdependent model, it is not
able to adjust, fully to the shocks which
are given, initially in the model. So, that
is where we will end today. In the next lecture,
we will talk about how to remove deficit and
surplus in the balance of payments. Thank
you.
