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Chapter 2

Q. 2.ST.1

Briefly explain how changes in various economic factors affect the U.S. current account balance.

Step-by-Step

Verified Solution

Each of the economic factors is described, holding other factors constant.

a. Inflation. A relatively high U.S. inflation rate relative to other countries can make U.S. goods less attractive to U.S. and non-U.S. consumers, which results in fewer U.S. exports, more U.S. imports, and a lower (or more negative) current account balance. A relatively low U.S. inflation rate would have the opposite effect.

b. National income. A relatively high increase in the U.S. national income (compared to other countries) tends to cause a large increase in demand for imports and can cause a lower (or more negative) current account balance. A relatively low increase in the U.S. national income would have the opposite effect.

c. Exchange rates. A weaker dollar tends to make U.S. products cheaper to non-U.S. firms and makes non-U.S. products expensive to U.S. firms. Thus, U.S. exports are expected to increase, while U.S. imports are expected to decrease.
However, some conditions can prevent these effects from occurring, as explained in the chapter. Normally, a stronger dollar causes U.S. exports to decrease and U.S. imports to increase because it makes U.S. goods more expensive to non-U.S. firms and makes non-U.S. goods less expensive to U.S. firms.

d. Government restrictions. When the U.S. government imposes new barriers on imports, U.S. imports decline, causing the U.S. balance of trade to increase (or be less negative). When non-U.S. governments impose new barriers on imports from the United States, the U.S. balance of trade may decrease (or be more negative). When governments remove trade barriers, the opposite effects are expected.