03 Jun Question 1. Question 1. Equation Sp+Sg = I+CA tells us that to
Question
1. Question 1. Equation Sp+Sg = I+CA tells us that to reduce a current account deficit, a country must increase its private savings, reduce domestic investment, or cut its government budget deficit. Nowadays, some people recommend imposing restrictions on imports from China (and other countries) to reduce the American current account deficit.
a) How would higher U.S. barriers to imports affect its private savings, domestic investment, and government deficit?
b) Do you agree that import restrictions will necessarily reduce a U.S. current account deficit?
2. Question 2. Explain how each of the transactions generates two entries – a credit and a debit – in the American balance of payments accounts, and describe how each entry would be classified:
a) An American purchases BMW 5 in Munich and pays for it using euros. He obtained those euros in exchange for dollars at the German bank in Munich airport.
b) An American buys a share of German stock, paying the seller with a check on an American bank.
c) An American buys a share of Japanese stock, paying by writing a check on an account with a Swiss bank.
d) The Korean government carries out an official foreign exchange intervention in which it uses dollars held in an American bank to buy Korean currency from its citizens.
e) A tourist from Detroit buys a meal at an expensive restaurant in Lyons, France, paying witha traveler’s check.
f) A California winemaker contributes a case of cabernet sauvignon for a London wine tasting.
g) A U.S.-owned factory in Mexico uses local earnings to buy additional machinery from a Mexican producer.
3. Question 3. Suppose that the U.S. net foreign debt (NFA<0) is 30 percent of U.S. GDP and that foreign assets and liabilities alike pay an interest rate of 3 percent per year. What would be the drain on U.S. GDP (as a percentage) from paying interest on the net foreign debt? Do you think this is a large number? What if the net foreign debt were 100 percent of GDP? At what point do you think a country's government should become worried about the size of its foreign debt?
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