Chapter 4: Problem 24

Suppose the U.S. economy began to grow more rapidly than other countries in the world. What would be the likely impact on U.S. financial markets as part of the global economy?

Short Answer

Expert verified

The rapid growth of the U.S. economy would likely lead to an increased demand and supply of U.S. financial assets, making them more attractive to investors and causing the U.S. dollar to appreciate. Asset prices would rise, while interest rates would decline. Though the stronger dollar would cause imbalances in the trade balance, increased foreign investment would mitigate the impact on the balance of payments. Overall, U.S. financial markets would play a larger role in the global economy, but might also face certain challenges and risks due to imbalances.

Step by step solution

Analyze the demand for U.S. financial assets

If the U.S. economy is growing more rapidly than other countries, its financial assets will become more attractive to both domestic and international investors who prefer higher returns from their investments. The U.S. dollar will appreciate, as investors buy dollars to acquire these more attractive financial assets.

Analyze the supply of U.S. financial assets

The rapid growth in the U.S. economy would lead to increased business activities, which may require additional financing. This may lead to an increase in the supply of U.S. financial assets, such as bonds and stocks, as companies issue more securities to finance their growth.

Analyze the impact on interest rates

As a result of the higher demand for U.S. financial assets, the prices of these assets are pushed higher. This would lead to a decrease in the expected returns from these assets (as price and returns are inversely related), which would typically lead to a decline in U.S. interest rates.

Analyze the impact on the U.S. dollar and the balance of payments

A stronger U.S. dollar as a result of the growing economy would make imports cheaper and exports more expensive, resulting in a deterioration of the U.S. trade balance. However, the increased attractiveness of U.S. financial assets would make it easier for the United States to attract foreign capital in the form of portfolio investment, mitigating the impact of the trade deficit on the balance of payments.

The overall impact on U.S. financial markets

The rapid growth of the U.S. economy would lead to increased demand and supply of U.S. financial assets, resulting in higher asset prices and lower interest rates. The U.S. financial markets would as a result become more attractive to both domestic and international investors, increasing the role of U.S. financial markets in the global economy. However, the stronger dollar and imbalances in the balance of payments may pose certain challenges and risks to the U.S. economy.