Chapter 10: Problem 2

If the trade deficit of the United States increases, how is the current account balance affected?

Short Answer

Expert verified

An increase in the trade deficit of the United States means that the value of imports is growing compared to exports, causing the trade balance component of the current account balance to become more negative (or less positive). This, in turn, reduces the current account balance, making it more negative or less positive. However, the overall impact on the current account balance also depends on changes in net income and net transfers during the same period.

Step by step solution

Define Trade Deficit and Current Account Balance

Trade Deficit: The trade deficit is the difference between the value of a country's imports and exports. A country has a trade deficit when it imports more goods and services than it exports. Current Account Balance: The current account balance is a measure of a country's total transactions with the rest of the world, including the trade balance, income from international investments, and net transfers from and to the country.

Understand the components of the current account balance

The current account balance is comprised of the following components: 1. Trade Balance: The difference between the value of a country's exports and imports of goods and services, i.e., trade deficit or surplus 2. Net Income: The difference between the income received from international investments and the income paid to foreign investors 3. Net Transfers: The difference between the transfers received from other countries and the transfers made to other countries (e.g., foreign aid, remittances)

Analyze the effect of an increased trade deficit

When the trade deficit of the United States increases, it means that the value of imports is increasing compared to the exports. This means that the trade balance component of the current account balance becomes more negative (or less positive).

Determine the impact on the current account balance

As the trade deficit increases, the trade balance component of the current account balance becomes more negative (or less positive). As a result, all else being equal, the current account balance will also decrease (i.e., become more negative, or less positive). However, it's important to note that the overall impact on the current account balance would also depend on the changes in net income and net transfers during the same period.

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