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International Accounting and Financial Equilibration

The discussion of the domestic side of the SAM representation explained equilibrating dynamics of two kinds: those around goods and service markets and those around financial assets and liabilities of agent-classes, especially government debt. On the international side of the SAM structure, the key equilibrating dynamic centers on the total level of international debt of a country. Changes in foreign reserves and short-term governmental borrowing play important short-term buffering roles Exchange rates are a key longer-term equilibrating variable.

Conceptual foundations for the dynamics build largely on two concepts discussed earlier in this chapter: current account balance (CURACT) and capital account balance (CAPACT). Although in terms of definition they are equal with opposite signs, it is more complicated than that. Current account equals the trade balance (TRADEBAL) of relative-price adjusted exports (XRPA) minus imports (MRPA), plus the net outflow of foreign aid (AID), plus foreign workers’ remittances to home countries, plus pension payments to retirees living abroad, plus the rents, interest, profits, and dividends paid on past capital inflows. Capital account equals the net inflow of underlying capital flows (the change in stocks), both long-term and short-term. The long-term includes foreign direct investment; the short term includes hot money in bank deposits and T-bills.

Although the current and capital accounts must balance, the balance often relies in the very short term on residual changes in stocks, namely reserve holdings and reactive government borrowing. In the longer-term exchange rate and interest rate fluctuations help maintain the balance by affecting the dynamics of the more slowly adjusting trade and longer-term financial flows.

IFs brings together most of these elements in its representations of the international financial dynamics around the SAM. It computes the current account balance from the elements indicated above, except that pension liabilities abroad are not represented. Workers’ remittances were incorrectly placed into the capital account formulation discussed below; they sign will be changed and they will be moved to the current account.

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Most of the above formulation is focused on determining the net interest, profit, dividend flows, which are specified as an exogenous interest rate (lintr) times the net stocks of assets mostly discussed earlier.

IFs then computes a limited (or partial) capital account balance from the elements of the capital account over which the government normally has least direct control [as noted earlier, worker remittances need to be moved to the current account]. The limited capital account balance purposefully excludes the two equilibrating elements of changes in reserves and short-term government compensatory borrowing.

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The model makes no assumption that it can anticipate a government’s relative choice between changes in reserves and changes in short-term government borrowing (XGOVTDEBTB) in order to achieve real balance between the current and capital accounts. Instead, it assumes that reserves will grow at a relatively steady rate over time [not yet implemented; change in reserves is now 0] and arbitrarily uses government debt as the buffering mechanism. Total governmental debt is now set as the short-term borrowing plus longer-term IFI credits and loans.

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Total external debt is the sum of governmental indebtedness and firm debt.

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Reserves change with delta reserves [not yet developed] and liquidity is definitionally the current account balance over reserves.

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Exchange rates are a function of external debt, using a PID controller mechanism to maintain relative balance with a target of zero over time.

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The exchange rates are actually computed and used in advance of trade balances and much else. They therefore must draw on debt data from a year earlier.

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The parameters used in the exchange rate adjustment above are second-order parameters computed from exogenous specifications (elerca1, elerca2). For entrepot economies with a high ratio of trade to GDP, the parameters are scaled back so as to avoid over-reaction.

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Once again, initialization of concepts with data was a challenge. The first step in the initialization of all financial stocks within the pre-processor is the processing of data on total external debt of countries (XDEBTRPA). The raw data came from the WDI 2002. Null values for developing countries are filled with zeros. Unfortunately, external debt data from the WDI are for developing countries only and there are no corresponding asset data for the lending countries, presumably mostly developed countries. As in other such instances, the pre-processor now assigns the total of external debt of developing countries to developed countries, defined for this purpose as countries with no external debt indicated and GDP per capita of $10,000 or more. The assignment is proportional to GDP of the more developed countries. Both the presumption that more developed countries are primarily asset holders and the proportional assignment are clearly inaccurate. The rationale for both is that the resultant stock assumptions, on average, are almost certainly better than assumptions that asset stocks of such countries are uniformly zero. Further, the dynamics of the model will be more greatly determined by change in stocks from initial levels than by the absolute values of them. Nonetheless, data on these assets would be highly desirable.

The next step is the reading of publicly-guaranteed and not-guaranteed debt, both of which are assumed to be held by firms and which are summed to obtain total external firm debt (XFIRMDEBT). Holes are filled with zeros because levels of debt are often very small and non-reporting often will imply debt levels near zero. Because the data only cover stocks of debt held by developing countries as liabilities, the stocks as assets were once again allocated to developed countries, specifically to firms within them, according to GDP size.

Not all of government debt is external. In fact, especially for developed countries, households and firms often hold much of it. In order to divide government debt between foreign and domestic holders of it, we first compute government external debt. This is done by assuming that households do not have any real external debt, so that all external debt not assignable to firms is governmental external debt.

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The assumption was again made that all of this debt should be assigned as assets to governments in developed countries. Rather than assigning it on the basis of GDP, however, it was assigned on the basis of official development assistance (ODA). The OECD and WDI both provide data on ODA. Because significant portions of ODA come as loans rather than grants, the assignment of the government asset offset of developing government debt based on the size of ODA makes sense.

Governmental domestic debt is calculated as total government debt minus the external stock.

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The WDI 2002 data set contained data on reserve holdings (XRESERVES). These are read by the pre-processor and null values are assigned zeros.