This article continues on from a previous entry in our macroeconomic blog category called Balance of Payments explained. This article provides an example of the national income accounting scheme in action within an open economy. Comments are always welcome.
Remember the income identity: Y = C + I + G + CA
Well in an open economy aggregate savings = Y – C – G = I + CA, OR, I = S-CA
To finance investment you can either go to the current account or savings (or borrow from the world). I (investment) is domestic investment financed by savings and foreign savings.
Some examples: Case 1 (Closed economy):
EX=IM, CA = 0, thus S=I (closed economy).
Case 2: (remember we plug into identity above)
CA>0, EX>IM, (FA<0), means there is a net capital outflow. If were to put numbers into the example we’d find out that private savings pays for the CA and G.
CA<0 (net capital inflow).
Those are three possible scenarios. Note, we can also conclude that a negative budget account does not always imply a negative current account.