Chapter 10: Problem 46

Imagine that the economy of Germany finds itself in the following situation: the government budget has a surplus of \(1 \%\) of Germany's GDP; private savings is \(20 \%\) of \(\mathrm{GDP} ;\) and physical investment is \(18 \%\) of GDP. a. Based on the national saving and investment identity, what is the current account balance? b. If the government budget surplus falls to zero, how will this affect the current account balance?

Short Answer

Expert verified

Given the provided information, we can calculate the current account balance as follows: \[ \text{Current Account Balance} = (20\% GDP + 1\% GDP) - 18\% GDP \] \[ \text{Current Account Balance} = 3\% GDP \] The current account balance is 3% of Germany's GDP. If the government budget surplus falls to zero, the new current account balance will be: \[ \text{New Current Account Balance} = (20\% GDP) - 18\% GDP \] \[ \text{New Current Account Balance} = 2\% GDP \] Thus, if the government budget surplus falls to zero, the current account balance will decrease by 1% of Germany's GDP (from 3% to 2%).

Step by step solution

Identify the national saving and investment identity

The National Saving and Investment Identity is given by: \[ \text{Current Account Balance} = (\text{Private Savings} + \text{Government Budget Surplus}) - \text{Physical Investment} \]

Calculate the current account balance

Given the values, we can calculate the current account balance as follows: \[ \text{Current Account Balance} = (20\% GDP + 1\% GDP) - 18\% GDP \] \[ \text{Current Account Balance} = 21\% GDP - 18\% GDP \] \[ \text{Current Account Balance} = 3\% GDP \] So, the current account balance is 3% of Germany's GDP.

Analyze the change in government budget surplus

In part b, we are given that the government budget surplus falls to zero. We will analyze how this change will affect the current account balance using the same national saving and investment identity.

Calculate the new current account balance

With the new government budget surplus of 0, we can calculate the new current account balance as follows: \[ \text{New Current Account Balance} = (20\% GDP + 0\% GDP) - 18\% GDP \] \[ \text{New Current Account Balance} = 20\% GDP - 18\% GDP \] \[ \text{New Current Account Balance} = 2\% GDP \] So, the new current account balance will be 2% of Germany's GDP.

Compare the current account balances

Comparing the current account balance before and after the change in government budget surplus, we can observe the effect of this change: \[ \text{Change in Current Account Balance} = \text{New Current Account Balance} - \text{Initial Current Account Balance} \] \[ \text{Change in Current Account Balance} = 2\% GDP - 3\% GDP \] \[ \text{Change in Current Account Balance} = -1\% GDP \] Thus, if the government budget surplus falls to zero, the current account balance will decrease by 1% of Germany's GDP.

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