Chapter 23: Problem 1

If foreign investors buy more U.S. stocks and bonds, how would that show up in the current account balance?

Short Answer

Expert verified

When foreign investors buy more U.S. stocks and bonds, it shows up as an increase in the financial account within the balance of payments, not directly in the current account balance. However, this increased demand for U.S. financial assets can indirectly affect the current account balance by causing the U.S. dollar to appreciate, making exports more expensive and imports cheaper. As a result, net exports may decrease, negatively impacting the current account balance.

Step by step solution

Understanding the Balance of Payments and Current Account Balance

The balance of payments is a summary of all economic transactions between a country and the rest of the world. It is divided into two main accounts: the current account and the capital account. The current account balance is the difference between a country's exports of goods and services and its imports of goods and services, plus the net income from abroad and net current transfers. A positive current account balance indicates that a country is a net lender to the rest of the world, while a negative balance indicates that it is a net borrower.

Understanding the impact of stocks and bonds transactions on the current account balance

When foreign investors buy U.S. stocks and bonds, they are essentially lending money to the U.S. economy. This transaction is recorded within the financial account of the balance of payments, not directly in the current account. The financial account records the flow of financial assets and liabilities between a country and the rest of the world, with an inflow of foreign capital being recorded as a positive value, and an outflow of capital being recorded as a negative value.

The indirect effects on the current account balance

While the transactions related to stocks and bonds do not directly affect the current account balance, they can have indirect effects. An increase in foreign demand for U.S. stocks and bonds usually leads to an appreciation in the value of the U.S. dollar. A stronger dollar can make U.S. exports more expensive and imports cheaper, which could result in a decrease in net exports, negatively impacting the current account balance.

Summing up

In summary, when foreign investors buy more U.S. stocks and bonds, it shows up as an increase in the financial account, which is a separate component from the current account balance within the balance of payments. However, increased demand for U.S. financial assets can indirectly affect the current account balance by causing the U.S. dollar to appreciate, making exports more expensive and imports cheaper, potentially leading to a decrease in the current account balance.

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