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Chapter 10: Q. 10 (page 265)

Explain the relationship between a current account deficit or surplus and the flow of funds.

Short Answer

Expert verified

Flow of funds is a part of current account surplus/deficit.

Step by step solution

01

Step1. Introduction

Imports refer to the buying of goods/services from foreign countries.

Exports refer to the selling of goods/services to foreign countries.

The international flow of funds refers to the flow of financial investments.

Current account balance refers to the trade surplus/deficit.

02

Step2. Explanation

The current account balance refers to the trade balance which is the net exports (exports minus imports). When a country runs a trade deficit, it imports more goods and services than it exports. Think of the US as an example--it pays USD for foreign imports, and this excess amount of USD comes back to the US in the form of investment in US financial assets (bonds, stocks, real estate, etc.).

A trade surplus means an overall outflow of financial investment capital, as domestic investors put their funds abroad; a trade deficit is exactly equal to the overall or net inflow of foreign investment capital from abroad.

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Most popular questions from this chapter

Using the national savings and investment identity, explain how each of the following changes (ceteris paribus) will increase or decrease the trade balance:

a. A lower domestic savings rate

b. The government changes from running a budget surplus to running a budget deficit

c. The rate of domestic investment surges

What are the main components of the national savings and investment identity?

Both the United States and global economies are booming. Will U.S. imports and/or exports increase?

Imagine that the U.S. economy finds itself in the

following situation: a government budget deficit of \(100 billion, total domestic savings of \)1,500 billion, and total domestic physical capital investment of \(1,600 billion. According to the national saving and investment identity, what will be the current account balance? What will be the current account balance if investment rises by

\)50 billion, while the budget deficit and national savings remain the same?

In 2001, the United Kingdom's economy exported

goods worth 拢192 billion and services worth another 拢77 billion. It imported goods worth 拢225 billion and services worth 拢66 billion. Receipts of income from abroad were 拢140 billion while income payments going abroad were 拢131 billion. Government transfers from the United Kingdom to the rest of the world were 拢23 billion, while various U.K government agencies received payments of 拢16 billion from the rest of the world.

a. Calculate the U.K. merchandise trade deficit for

2001.

b. Calculate the current account balance for 2001.

c. Explain how you decided whether payments on

foreign investment and government transfers

counted on the positive or the negative side of

the current account balance for the United

Kingdom in 2001.
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