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Chapter 29: Problem 1

What is the relationship among the current account, the financial account, and the balance of payments?

Short Answer

Expert verified
The current account, financial account, and balance of payments record a nation's economic transactions with the rest of the world. A deficit in the current account is financed by a surplus in the financial account and vice versa. The balance of payments, which equals to zero, is the sum of the current account and the financial account.

Step by step solution

01

Explain the Components

Firstly, recognize that the current account records a nation's transactions with the rest of the world for goods, services, income, and current transfers. This includes exports, imports, income earned on international assets, and international aid.
02

Financial Account Overview

Next, note that the financial account tracks the net change in ownership of national assets. It records investments in business, real estate and bonds, amongst others.
03

Link the Current and Financial Accounts

Now, you need to know that a deficit in the current account needs to be financed by a surplus in the financial account and vice versa. This means if a country's current account is in surplus, it is a net lender to the rest of the world, and if it's in deficit, it is a net borrower from the rest of the world.
04

Balance of Payments

Finally, the balance of payments, which is the broadest accounting of a nation's international transactions, is the sum of the current account and the financial account. This means that the balance of payments always balances, or in other words, it always equals zero, because it measures both sides of every transaction.

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Most popular questions from this chapter

Section 29.4 states that "the budget surpluses of the late 1990 s occurred at a time of then-record current account deficits." Holding everything else constant, what would the likely effect have been on domestic investment in the United States during those years if the current account had been balanced instead of being in deficit?

A 2017 article in the Wall Street Journal noted, "President Donald Trump said Wednesday the U.S. dollar 'is getting too strong' and he would prefer the Federal Reserve keep interest rates low." Is there a connection between the president's two observations about economic policy? Briefly explain.

Why do foreign households and foreign firms demand U.S. dollars in exchange for foreign currency? Why do U.S. households and firms supply U.S. dollars in exchange for foreign currency?

In its 2016 Annual Report, Amazon stated, "We have foreign exchange risk." a. Briefly explain why Amazon is exposed to foreign exchange risk. b. If Amazon did not have operations in foreign countries, would its profit be affected in any way by fluctuations in the exchange value of the U.S. dollar? Briefly explain.

(Related to Solved Problem 29.1 on page 1034 ) In early 2017 . a Chinese news service noted, "The country will continue to run a current account surplus, as well as a ... financial account deficit in 2017 ." After reading this account, a student comments, "I thought Chinese exports were very strong, so I don't understand why the country is expected to run a financial account deficit." Clear up the student's confusion.
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