Question

1. What does it mean to have a current account deficit? Explain in terms of net foreign assets, absorption, and the capital and financial accounts.

2. In a previous question, you considered a trade in automobiles between the United States and Europe. Like that example, a dollar depreciation results in a "dip" of net import before a favorable trade balance. This "dip" is counter-intuitive because the dollar depreciation should make the exports from the U.S. cheaper and the imports to the U.S. more expensive. Please explain this short/medium-term worsening of trade balance.

3.

Although China's policy to maintaining their currency at a lower value has been in place for a while, it is an expensive - or even risky - policy to implement.

Suppose the value of yuan falls in value, then investors would sell their yuan-valued assets to avoid loss and buy assets valued in other currencies (dollars, euro, yen, …) This will further decrease the demand for yuan. What intervention does the Chinese government need to make in order to maintain the value of yuan & what would a speculative attack could play a role in this situation?

4 While you studied the long-run determination of foreign exchange in Data Report, the short-run determination is also critical to understand the foreign exchange market. (This is especially so if you are an investor who cannot wait for a decade.) Consider a case where the U.S. Federal Reserve raise is interest rate, while EU lowers its interest rate. What would be the impact on the market for the U.S. dollars? Describe the outcome (i.e. equilibrium rate) and explain how the demand for and supply of the U.S. dollars change in response to those two events.

Answer 1

Answer 1 - The current account of the BOP does not deal with the assets and liabilities of the economy. Rather it deals with the export and import of goods and services , unilateral transfers and interest income or interest payments on the investments which are recorded in capital account.

When the debit side balance of current account is greater than the credit side , it is called Current Account Deficit. This means that there is outflow of capital from the economy . The imports are greater than exports , the interest payments are greater than receipts and more has been transfered unilaterally than has been received.