Can external sustainability be decoupled from the NIIP?

A prominent feature within the sphere of international macroeconomics surrounds the notion of the domestic economy succumbing to a “sudden stop” — i.e. the point at which creditors are no longer willing to enter into fresh exposures vis-à-vis debtors. One avenue which has been increasingly adopted as a means to survey a nation’s external sustainability (i.e. its vulnerability to sudden stops) is through the net international investment position (NIIP) — the difference between stocks of cross-border claims and liabilities. On the basis that financial account transactions are larger than current account transactions in terms of both volume and value, this paper by conjoining several strands of the international macroeconomics literature presents three motivations to suggest that the notion of external sustainability can be decoupled from the NIIP, namely that while a nation may in theory be a net creditor vis-à-vis the rest of the world in accordance with its NIIP, in reality, its susceptibility to sudden stops may be larger than an economy which is a net debtor as a consequence of (1) stock or (2) flow effects. Moreover, should the domestic economy succumb to a sudden stop as a result of either stock or flow effects, (3) this may not translate into changes to NIIP, thereby masking the fact that even though the domestic economy has succumbed to balance of payments difficulties, it continues to appear as a net creditor. To achieve its objectives, each motivative factor is presented through systems of financial accounts. Separate annexes also disseminate how delays between payment and settlement result in credit risks, in addition to how exchange rate fluctuations can impose accounting losses/gains on the balance sheets of counterparties.