1. Is the budget deficit of a country linked to its current account balance? If

Question

1. Is the budget deficit of a country linked to its current account balance? If so, how so? If not, why not? Explain how it is possible for the United States’ current account deficit to grow while the budget deficit has disappeared. Hint: There’s an equation that will help answer this question.

2. When looking at a nation’s financial account, is it possible to determine the total amount of official reserves available to that nation? If so, explain why. If not, explain why not

3. What can you say about the sign of the financial account if the government budget is balanced, and S is greater than I? Why?

Explanation / Answer

Multiple questions asked.

First question is answered below.

1.

Current account balance refers to the sum of the balance of trade of goods and services (exports less imports), net factor income from abroad and net-current transfers.

Budget deficit refers to excess of government expenditure over government revenues.

A budget deficit will lead to a current account deficit if the business and household sectors don’t save enough to finance that deficit. That is, when savings by households and businesses fall, budget deficit leads to current account deficit. This is also known as the Twin deficit Hypothesis.

Numerically, Budget Deficit = Savings - Investment + Trade Deficit

Thus, when savings and investment fall, budget deficit leads to current account deficit

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