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External Imbalance

External Imbalance[1]

Presently much is being said about the Portuguese external economic imbalance.  Probably due to the fact that this country is under a bailout program headed by a troika of international institutions[2]. But what is that external economic imbalance? There are several aspects that explain it, though the central idea is an imbalanced flow of money between Portugal and the World.

Think Portugal as a person. Different persons engage in exchanges in a daily basis trading goods, services and factors of production between them and so does Portugal with the World (in aggregate terms). In the end, after all exchanges have been accounted for, if Portugal sees more money going out than coming in of its “pocket” then it is “imbalanced”.

To understand this let us draw a simple model. As said before the individual of interest is Portugal. This “individual” engages in trade with others, which can be captured by its imports and exports. The latter being the way of generating income to spend on the former (the desired goods and services that other “individuals” produce). Time will be reflected in the two period logic of this model: Portugal will engage in trade both in present (year 0) and in future (year 10). This 10 year span really stresses out the implicit contract that each individual does when balancing resources between the present and the future.  Its “pocket” will be defined as the possible combinations between its total present value and total future value of income: Portugal either spends all its possible income in the present or it spends all its possible income in the future or something in the middle. An interest rate is needed to compute these values: at year 10, the total possible income will be that year exports plus year 0 capitalized saved exports and, at year zero, the total possible income will be that year exports plus year 10 anticipated exports at a capitalization cost. This interest rate is just an average of the 10 year government bond interest rate of Germany, USA and Japan. This interest rate specification is somewhat subjective, but is believed to have important properties for this model: its term suits our 10 year span between periods, it is robust because takes in account three of the most representative economies and it is risk free.

Applying this model to the period 2000\2010 renders a consumption bundle of imports of €51.9\€62.8 (Graph 1 helps to visualize it). In 2000 value, that bundle means €112.4, while the present value of income (2000 exports plus 2010 exports at 2000 value) totaled €85.4 generating a trade “imbalance” of €26.9. This can be found in Table 1 and for decades 1989\1999 up to 2002\2012. It is striking the persistent record of “imbalances” between Portugal of a given year and the same “individual” 10 years later. The explanation for this lies away of our simple model: flows of external credit have been allowing this kind of behavior. It is, then, no surprise why Portugal ended up to be intervened by the troika… Portugal, like anyone of us, cannot persistently run out of its “pocket” without consequences.

  Table 1

Year of Period 1 Year of Period 2 Average Interest Rate Present Value of Exports Present Value of Imports “Imbalance”
2002 2012 2,98% 92,5 € 105,8 € -13,4 €
2001 2011 3,81% 89,7 € 109,6 € -19,9 €
2000 2010 3,87% 85,4 € 112,4 € -26,9 €  
1999 2009 4,49% 78,3 € 106,2 € -27,9 €
1998 2008 3,58% 82,8 € 109,0 € -26,3 €
1997 2007 4,35% 79,9 € 101,3 € -21,5 €
1996 2006 4,99% 74,1 € 94,0 € -19,9 €
1995 2005 4,89% 67,5 € 88,2 € -20,7 €
1994 2004 6,67% 63,5 € 83,2 € -19,6 €
1993 2003 4,88% 60,4 € 77,4 € -17,0 €
1992 2002 6,22% 58,3 € 77,4 € -19,1 €
1991 2001 6,71% 56,0 € 74,6 € -18,6 €
1990 2000 7,86% 54,9 € 71,7 € -16,7 €
1989 1999 6,99% 50,1 € 66,2 € -16,2 €

[1] All monetary values are at 2005 prices, in 1.000.000.000€, rounded to the first decimal. Exports and imports come from AMECO. Bonds’ interest rates come from Bloomberg.

[2]  The IMF, the EC and the ECB.

João Firmino

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Author: studentnovasbe

Master student in Nova Sbe

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