Deck 5: Saving and Investment in the Open Economy

Question 1

The world as a whole has a current account deficit because

A) some countries export less than they import.
B) There are statistical discrepancies.
C) The United States and China have current account deficit.
D) Income from assets held abroad is misreported.

Answer 1

D

Question 2

The difference between the current account balance and net exports is

A) the capital account.
B) net unilateral transfers plus net factor payments from abroad.
C) adjustments in net foreign assets.
D) income receipts from foreign assets.

Answer 2

B

Question 3

Which of the following would be part of the nation's capital account?

A) a nightclub show seen by a Canadian in Mexico City
B) a dividend from a British equity owned by a Canadian
C) a payment to the Philippine government for the use of military bases in their country
D) one hundred shares of British Petroleum stock purchased by a Canadian

Answer 3

D

Question 4

Canada's balance of payment accounts

A) are a record of all Canadian international transactions.
B) are part of the national income accounting.
C) show a flow of funds into Canada as credit and the flow of funds out of Canada as debit.
D) all of the above.

Question 5

If a French company sells 1000 gallons of Perrier to a Canadian company at 25 francs per gallon and uses the money to buy stock in a Spanish cork company, how does this affect the French balance of payments accounts?

A) debit: capital account; credit: merchandise trade
B) debit: merchandise trade; credit: capital account
C) debit: net investment income from abroad; credit: capital account
D) debit: merchandise trade; credit: net investment income from abroad

Question 6

Which of the following would be part of the nation's current account?

A) an old house purchased by a Canadian in Croatia
B) the purchase of a Canadian Treasury bond by a foreigner
C) the interest a Canadian earns on a British bond
D) a factory built by the Japanese in Canada

Question 7

If all international factor payment flows are investment income, then net investment income from abroad equals

A) net exports.
B) the current account balance.
C) the trade balance.
D) net factor payments from abroad.

Question 8

The official settlements balance equals

A) the sum of the current account and the capital account.
B) the current account minus net unilateral transfers.
C) net investment income from abroad.
D) the net increase in a country's official reserve assets.

Question 9

If France has a trade deficit, then

A) imports into France exceed exports from France.
B) exports from France exceed imports into France.
C) imports into Canada from France exceed exports from Canada into France.
D) imports into France from Canada exceed exports from France into Canada.

Question 10

Which of the following statements is true?

A) The world as a whole has a current account surplus.
B) The world as a whole has a current account balance.
C) The world as a whole has a balance of payment surplus.
D) The world as a whole has a current account deficit.

Question 11

The current account balance consists of

A) the trade balance plus the services balance.
B) net exports of goods and services, minus net unilateral transfers.
C) net exports of goods and services, plus investment income from abroad, plus net unilateral transfers.
D) net exports of goods and services, plus investment income from abroad, plus net unilateral transfers, minus the capital account balance.

Question 12

If the Bank of Canada buys $3 billion worth of Japanese yen, $4 billion of German marks, and $2 billion of French francs, and sells $5 billion of British pounds, how does this affect the official settlements balance?

A) falls by $4 billion
B) rises by $4 billion
C) rises by $9 billion
D) falls by $5 billion

Question 13

If Canada donates footballs to Japan, how is the transaction recorded on the Canadian balance of payments accounts?

A) debit: merchandise trade; credit: capital account
B) debit: capital account; credit: merchandise trade
C) debit: net unilateral transfers; credit: merchandise trade
D) debit: merchandise trade; credit: net unilateral transfers

Question 14

If a country's merchandise exports exceed its merchandise imports,

A) it has a trade surplus.
B) it has a trade deficit.
C) it has a current account surplus.
D) it has a current account deficit.

Question 15

The merchandise trade balance is a country's

A) exports of goods.
B) net exports of goods.
C) exports of goods and services.
D) net exports of goods and services.

Question 16

If a Canadian firm buys stereos from a Japanese firm and the Japanese firm uses the dollars it gets to buy Canadian Treasury bonds, what items are recorded in the Canadian balance of payments accounts?

A) credit the trade account; credit the capital account
B) credit the trade account; debit the capital account
C) debit the trade account; debit the capital account
D) debit the trade account; credit the capital account

Question 17

If a Canadian company imports 10 Toyotas from Japan at $15,000 each, and the Japanese company buys airline tickets on a Canadian airline with the money, how does this affect the Canadian balance of payments accounts?

A) debit: merchandise trade; credit: capital account
B) debit: capital account; credit: merchandise trade
C) debit: merchandise trade; credit: services
D) debit: services; credit: merchandise trade

Question 18

Suppose a wealthy Saudi Arabian prince donates 2000 camels to the San Diego Zoo. The Canadian trade balance ________ and the current account balance ________.

A) falls; rises
B) rises; rises
C) is unchanged; is unchanged
D) falls; is unchanged

Question 19

Suppose the current account shows debits of $4.7 billion and credits of $5.3 billion. The current account balance is ________, and the capital account balance is ________.

A) +$0.6 billion; -$0.6 billion
B) +$0.6 billion; +$0.6 billion
C) -$0.6 billion; -$0.6 billion
D) -$0.6 billion; +$0.6 billion

Question 20

A capital account surplus necessarily implies

A) a balance of payments surplus.
B) a current account surplus.
C) a current account deficit.
D) an increase in the nation's official reserve assets.

Question 21

When a current account has a surplus of $5 billion, it means that

A) the capital account must have a deficit of $5 billion.
B) next exports must be negative.
C) net foreign lending is negative.
D) net acquisition of foreign assets is negative.

Question 22

A small open economy has a current account balance of zero. A rise in its investment demand causes

A) a current account surplus.
B) a capital account deficit.
C) income to exceed absorption.
D) net borrowing from abroad.

Question 23

A small open economy increases its investment demand. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) rise; fall
B) remain unchanged; rise
C) rise; rise
D) remain unchanged; fall

Question 24

An economy in which output exceeds absorption

A) will send goods abroad and have a current account surplus.
B) is a net importer with a current account deficit.
C) is a net borrower in the international market.
D) will have a capital account deficit.

Question 25

Which of the following statement is true?

A) In each period, except for measurement errors, the current account balance and the capital account balance must sum to zero.
B) In each period, except for measurement errors, the sum of the current account balance and the capital account balance must be positive.
C) In each period, except for measurement errors, the sum of the current account balance and the capital account balance must be negative.
D) In each period, except for measurement errors, the sum of the current account balance and the capital account balance may be positive or negative.

Question 26

You just read that forecasters predict Canada will run a current account deficit in 2004. From this you would infer that Canada will also

A) run a capital account deficit in 2004.
B) decrease its official reserve assets.
C) run a balance of payments surplus.
D) decrease its holding of net foreign assets.

Question 27

If Canada acquired net foreign assets of $50 billion in one year, this would be the equivalent of

A) net imports of $50 billion.
B) net foreign borrowing of $50 billion.
C) a capital account deficit of $50 billion.
D) a current account deficit of $50 billion.

Question 28

If there are no factor payments from abroad and no unilateral transfers, net exports of $10 billion is the same as

A) a current account deficit of $10 billion.
B) a capital account surplus of $10 billion.
C) net acquisition of foreign assets of $10 billion.
D) net foreign borrowing of $10 billion.

Question 29

Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Net foreign lending would be equal to

A) -$4 billion.
B) -$2 billion.
C) $2 billion.
D) $4 billion.

Question 30

Sweetland economy's GDP is $2000 billion, desired consumption spending $1200 billion, desired investment spending $500 billion, and government purchases $400 billion. The Sweetland economy's absorption is

A) $2000 billion.
B) $1200 billion.
C) $2100 billion.
D) -$100 billion.

Question 31

Absorption refers to

A) the total amount of imports purchased by a country.
B) the net amount of imports purchased by a country.
C) total spending by domestic residents, businesses, and governments.
D) GDP less desired consumption, desired investment, and government purchases.

Question 32

A friend claims that Canada is a net international debtor. The best way of testing this claim is to

A) see whether Canadian foreign liabilities exceeded Canadian foreign income.
B) see whether Canadian receipts from foreign assets exceeded Canadian payments to foreign owners of Canadian assets.
C) see whether Canadian official reserve assets were positive or negative.
D) see whether Canada ran a balance of payments surplus or deficit last year.

Question 33

Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Absorption is equal to

A) $25 billion.
B) $31 billion.
C) $35 billion.
D) $39 billion.

Question 34

In goods market equilibrium in an open economy,

A) the desired amount of exports must equal the desired amount of imports.
B) the desired amount of exports must equal the desired amount of imports less the amount lent abroad.
C) the desired amount of national saving must equal the desired amount of domestic investment.
D) the desired amount of national saving must equal the desired amount of domestic investment plus the amount lent abroad.

Question 35

Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Desired savings is equal to

A) $2 billion.
B) $10 billion.
C) $14 billion.
D) $16 billion.

Question 36

A small open economy is an economy that

A) has a small government.
B) has a very low net exports.
C) is too small to affect the world real interest rate.
D) has a negative balance of payments.

Question 37

In goods market equilibrium in an open economy,

A) the desired amount of exports must equal the desired amount of imports.
B) the desired amount of exports must equal the desired amount of imports less the amount lent abroad.
C) the desired amount of national saving must equal the desired amount of domestic investment.
D) the desired amount of national saving must equal the desired amount of domestic investment plus the current account balance.

Question 38

For a small open economy, an increase in the world real interest rate would necessarily

A) increase net foreign lending.
B) decrease net exports.
C) decrease the current account balance.
D) worsen the balance of payments.

Question 39

Which of the following statements about the Canadian balance of payment is true?

A) Historically, Canada has for the most part had a current account surplus.
B) Canada has always had a capital account deficit.
C) Canadians' ownership of foreign assets has always been greater than foreigners' ownership of Canadian assets.
D) Canada has always maintained a current account balance.

Question 40

A small open economy has a current account balance of zero. A rise in the world real interest rate causes

A) a current account surplus.
B) a capital account surplus.
C) net borrowing from abroad.
D) absorption to exceed income.

Question 41

A large open economy increases its investment demand. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) rise; fall
B) remain unchanged; rise
C) rise; rise
D) remain unchanged; fall

Question 42

When there are two large open economies, the world real interest rate will be such that

A) desired international lending by one country equals desired international borrowing by the other country.
B) desired international lending will be the same in both countries.
C) desired international borrowing will be the same in both countries.
D) desired international lending and borrowing will be zero in both countries.

Question 43

If there is an increase in taxes on business firms in a small open economy, it causes the current account to ________ and saving ________.

A) fall; fall
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; fall

Question 44

A large open economy increases its desired saving. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) fall; fall
B) remain unchanged; rise
C) fall; rise
D) remain unchanged; fall

Question 45

When future labour income falls in a small open economy, it causes the current account to ________ and investment to ________.

A) fall; rise
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; rise

Question 46

A small open economy increases its desired saving. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) fall; fall
B) remain unchanged; rise
C) fall; rise
D) remain unchanged; fall

Question 47

When there are two large open economies, if desired international borrowing by the domestic country exceeds desired international lending by the foreign country, then

A) domestic investment must fall.
B) domestic investment must rise.
C) the world real interest rate must fall.
D) the world real interest rate must rise.

Question 48

Which of the statements below is not a reason for the high level of lending to less developed countries in the 1970s?

A) Most countries borrow large amounts of money in the initial stages of development.
B) The world real interest rate was high in the 1970s.
C) In a growing developing economy, investment opportunities exceed the domestic population's capacity to save.
D) The OPEC price increases caused consumers in non-oil-exporting LDCs to reduce their savings.

Question 49

If there is an increase in the future marginal product of capital in a small open economy, it causes the current account to ________ and saving to ________.

A) fall; rise
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; rise

Question 50

You have just read in the newspaper that a hurricane has destroyed Guatemala's coffee crop for this year. Guatemala is a small open economy. Based on this information alone, you would expect that

A) desired investment would fall in Guatemala.
B) desired investment would increase in Guatemala.
C) net foreign lending by Guatemala would increase.
D) net foreign lending by Guatemala would decrease.

Question 51

If there is an increase in the future marginal product of capital in a large open economy, it causes the current account to ________ and saving to ________.

A) fall; rise
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; rise

Question 52

When a temporary adverse supply shock hits a large open economy, it causes the current account to ________ and investment to ________.

A) fall; fall
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; fall

Question 53

The best weather in a decade has given Australia a bumper wheat crop. Australia is a small open economy. Based on this information alone, you would expect that

A) desired investment would decrease.
B) desired investment would increase.
C) the current account would increase.
D) the current account would decrease.

Question 54

A large open economy is an economy

A) that has a large government sector.
B) that has a positive net exports.
C) that is large enough to affect the world real interest rate.
D) that has a positive balance of payments.

Question 55

One important reason why the loans to less developed countries went bad was

A) lower inflation rates in developed countries.
B) higher oil prices after 1982.
C) larger government deficits among developing countries.
D) higher interest rates in the early 1980s.

Question 56

When a temporary adverse supply shock hits a small open economy, it causes the current account to ________ and investment to ________.

A) fall; fall
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; fall

Question 57

When there are two large open economies, if desired international lending by the domestic country exceeds desired international borrowing by the foreign country, then

A) domestic saving must rise.
B) domestic saving must fall.
C) the world real interest rate must fall.
D) the world real interest rate must rise.

Question 58

The main difference between the small open economy and the large open economy is that

A) the former faces a fixed international real interest rate, but the latter can influence it.
B) the former can influence the international real interest rate, but the latter cannot.
C) the former cannot maintain a large current account deficit, but the latter can.
D) the former can maintain a large current account deficit, but the latter cannot.

Question 59

When future labour income falls in a large open economy, it causes the current account to ________ and investment to ________.

A) fall; rise
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; rise

Question 60

An innovation will enable Haitian sugar cane farmers to harvest the sugar cane twice as efficiently in the future. Haiti is a small open economy. Based on this information alone, you would expect that

A) desired saving would increase.
B) net foreign borrowing would increase.
C) net exports would increase.
D) the current account balance would go further into surplus.

Question 61

Suppose a country has the following balance of payments data:
Merchandise exports 100
Merchandise imports 130
Service exports 60
Service Imports 50
Investment income receipts 75
Investment income payments 100
Transfers to other countries 15
Increase in home country assets abroad 130
Increase in foreign assets in home country 190
a. Calculate the current account balance.
b. Calculate the capital account balance.
c. Calculate the trade balance.
d. Calculate net factor payments.

Question 62

Real domestic interest rates would increase in a large open economy if

A) there were a temporary negative domestic supply shock.
B) the government imposed capital controls and the capital account had been in deficit.
C) foreigners were more willing to save.
D) there were a temporary negative supply shock abroad in a small open economy.

Question 63

Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government's action to

A) increase the current account balance by exactly 10 million colon.
B) increase the current account balance by less than 10 million colon.
C) reduce the current account balance by exactly 10 million colon.
D) reduce the current account balance by more than 10 million colon.

Question 64

Consider a small open economy with desired national saving of S^d = 20 + 200 r^w and desired investment of I^d = 30 - 200 r^w. Calculate national saving, investment, and the current account balance in equilibrium when the real world interest rate is
a. r^w = 0.025
b. r^w = 0.05
c. r^w = 0.0
d. Now suppose something causes desired national saving to increase by 10, so that it is now S^d = 30 + 200 r^w. Repeat parts a, b, and c.
e. Suppose, with desired national saving at its original level of S^d = 20 + 200 r^w, something causes desired investment to rise by 10, I^d = 40 - 200 r^w. Repeat parts a, b, and c.

Question 65

Assuming no change in the effective tax rate on capital, an increase in the government budget deficit will raise the current account deficit if and only if the increase in the budget deficit

A) reduces desired national saving.
B) increases desired national saving.
C) reduces desired national investment.
D) increases desired national investment.

Question 66

In a small open economy,
S^d = $20 billion + ($100 billion) r%
I^d = $30 billion - ($100 billion) r%
Y = $70 billion
G = $20 billion
r^w = .04.
a. Calculate the current account balance.
b. Calculate net exports.
c. Calculate desired consumption.
d. Calculate absorption.

Question 67

Due to a change in the regulatory structure of a small open economy, the desired capital stock becomes higher for both private investment and government investment. Increased government investment spending is financed by borrowing, not by higher taxes. If both desired investment and government spending rise at the same time, will there be "twin deficits"?

Question 68

Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?

Question 69

If Ricardian equivalence proposition is true, a budget deficit resulting from a tax cut will have

A) no effect on government expenditures.
B) no effect on current account because it does not affect national saving.
C) no effect on current account because people expect to pay lower taxes in the future.
D) no effect on current account because people expect to increase their consumption.

Question 70

Consider a small open economy in equilibrium with a zero current account balance. What happens to national saving, investment, and the current account balance in equilibrium if
a. future income rises?
b. business taxes rise?
c. government expenditures decline temporarily?
d. the future marginal product of capital rises?

Question 71

A large open economy has desired national saving of S^d = 20 + 200 r^w and desired national investment of I^d = 30 - 200 r^w. The foreign economy has desired national saving of S^d = 40 + 100 r^w and desired national investment of I^d_For = 75 - 400 r^w.
a. Calculate the equilibrium values of r^w, CA, CA_For, S, I, S_For, and I_For.
b. Suppose S^d rises by 45, so that now S^d = 65 + 200 r^w. Calculate the equilibrium values of r^w CA, CA_For, S, I, S_For, and I_For.
c. Suppose with S^d back to S^d = 20 + 200 r^w as in part a, that I^d rises by 45, to I^d = 75 - 200 r^w. Calculate the equilibrium values of r^w, CA, CA_For, S, I, S_For and I_For.

Question 72

Show where each of the following transactions belongs on the Canadian balance of payments table, using an exchange rate of 100 Japanese yen per Canadian dollar.
a. A Japanese firm spends 5 billion yen to buy personal computers from IBM (a Canadian firm).
b. A wealthy Japanese businessman gives $100 thousand to the San Diego Zoo.
c. A Canadian firm buys 1 million Sony Walkmans at 6000 yen each (Sony is a Japanese firm).
d. A Japanese investment banking firm buys 500 million dollars worth of newly issued Canadian government Treasury bills.
e. Canadian steel firms send 2000 executives to Japan to take courses in the Japanese method of steel production and Japanese management techniques, paying 2 million yen per executive.
f. Repeat parts a. - e. for the balance of payments table of Japan.

Question 73

Suppose the government of a large open economy announces a major expansion of government spending to dig a tunnel to the earth's core, to be financed entirely by borrowing. What effect does this have on the world real interest rate, national saving, investment, and the current account balance in equilibrium?

Question 74

The government of a small open economy announces a tax cut of $100 this year, combined with a tax increase of $110 next year, when the interest rate is 10%. What are the effects of this change on the world real interest rate, national saving, investment, and the current account balance in equilibrium when
a. Ricardian equivalence holds?
b. Ricardian equivalence does not hold?

Question 75

In a large open economy like the United States, an increased government budget deficit that reduces national saving

A) reduces investment and improves the current account balance.
B) reduces investment and reduces the current account balance.
C) has no effect on investment, but reduces the current account balance.
D) has no effect on either investment or the current account balance.

Question 76

The term "twin deficits" refers to a situation in which there exists

A) a budget deficit as well as a current account deficit.
B) a budget deficit as well as a capital account deficit.
C) a budget deficit as well as a balance of payment deficit.
D) a current account deficit as well as a capital account deficit.

Question 77

Assume that Costa Rica, a small open economy, has increased the government budget deficit by 10 million colon, reducing the current account balance in the process. All else being equal, you would expect this action to cause

A) an increase in desired saving in Costa Rica.
B) an increase in the real world interest rate.
C) an increase in exports by Costa Rica.
D) an increase in Costa Rica's absorption.

Question 78

Consider a large open economy that has a zero current account balance. What are the effects on the world real interest rate, national saving, investment, and the current account balance in equilibrium if
a. future income rises?
b. business taxes decline?
c. government purchases decline?
d. the future marginal product of capital declines?

Question 79

If business taxes rise in a large open economy, it causes the current account to ________ and saving to ________.

A) fall; fall
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; fall