If the current account balance is initially 0 in a two nation world (i.e. U.S. a
ID: 1138105 • Letter: I
Question
If the current account balance is initially 0 in a two nation world (i.e. U.S. and China), and the U. S. Treasury borrows $100 billion to finance the budget deficit, ceteris paribus, this will result in:
no change in the U.S. current account.
-$100 billion of trade deficit.
both a trade surplus of $100 billion and a capital inflow of $100 billion.
$100 billion of trade surplus.
no change in the U.S. current account.
-$100 billion of trade deficit.
both a trade surplus of $100 billion and a capital inflow of $100 billion.
$100 billion of trade surplus.
Explanation / Answer
Ans.
B. -$100 billion of trade deficit
The U.S treasury has borrowed $100 to finance the budget deficit , then it creates trade deficit. Trade deficit occurs when imports exceeds than exports. Trade deficit means country is borrowing from abroad to cover its budget deficit. The budget deficit usually widens trade deficit. That means when government creates budget deficit with combination of tax cuts and increased spending , it will increase aggregate demand in an economy. That increase in aggregate demand leads to higher level of imports. Such that imports are more than exports , so there is trade deficit. However by borrowing there is an equal increase in the trade deficit.
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