Question

Explain the relationship between net capital outflows and a nation’s trade balance. Explain whether most (not Peter Navarro) economists consider a trade deficit to be an issue for the United States and why. Explain what purchasing power parity (PPP) implies about the relationship between nominal exchange rates and price levels. Explain whether PPP accurately portrays the current relationship nominal exchange rates and price levels across nations and why.

Answer 1

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Question:

Answer:

Net Capital Outflow:

Net capital outflow is the net flow of funds being invested abroad by a country during a certain period of time. A positive NCO means that the country invests outside more than the world invests in it and negative NCO means that the country invests outside less than the world invests in it. Simply, Net capital outflow measures the imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners.

When the interest rate decreased or the economy in trouble and falling sharply or economic is enter in recession phase then investors sell the assets and move toward where economy is stable or growing fast or has higher interest rate/return and increase net cash outflow.

Trade Balance:

The trade balance, also known as the balance of trade (BOT), is the calculation of a country's exports minus its imports.

Relationship between net capital outflows and a nation’s trade balance:

We know that  Net exports are the value of a nation's exports minus the value of its imports, also called the trade balance. Net capital outflow is the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. Net exports equal net capital outflow.

When import is more than export (trade deficit) then net cash flow is positive and vice-versa.

Whether most (not Peter Navarro) economists consider a trade deficit to be an issue for the United States and why.

Trade deficit means total import is higher than total export. It means when a country import more capital, goods and services than its export then called that country has trade deficit. Currently USA is supporting and promoting the free trade. Because of this policy USA is facing the many challenges. The latest US-China trade war is the perfect example of it. So, many economist arguing that free trade policy is affecting US trade balance and increasing trade deficit regularly.

The trade deficit affects the US economy in several ways like, First, the steady growth in our trade deficits over the past two decades has eliminated millions of U.S. manufacturing jobs.Between 1979 and 1994, trade eliminated 2.4 million jobs in the U.S. Second,The growth in imports, especially from low-wage countries, also puts downward pressure on the wages of U.S. workers. If the prices of these products fall, then this puts downward pressure on prices in the U.S. Domestic firms are then forced to cut wages or otherwise reduce their own labor costs in response.The third problem with trade deficits is their corrosive effect on our long-term trade competitiveness. When the U.S. dollar and our trade deficit soared in the early 1980s, many domestic firms and industries in sectors such as steel and semiconductors were decimated. Once closed, many plants in such industries failed to re-open, even after the dollar depreciated later in the 1980s.

Explain what purchasing power parity (PPP) implies about the relationship between nominal exchange rates and price levels.

PPP-

Purchasing power parity (PPP) is a measurement of prices in different countries that uses the prices of specific goods to compare the absolute purchasing power of the countries' currencies or in simple term Purchasing power parity (PPP) is an economic theory that allows the comparison of the purchasing power of various world currencies to one another.

Purchasing power parity (PPP) is an economic theory of exchange rate determination. It states that the price levels between two countries should be equal.This means that goods in each country will cost the same once the currencies have been exchanged.

Example: if the price of a Coca Cola in the UK was 100p, and it was $1.50 in the US, then the GBP/USD exchange rate should be 1.50 (the US price divided by the UK’s) according to the PPP theory.

Explain whether PPP accurately portrays the current relationship nominal exchange rates and price levels across nations and why.

Nominal Exchange Rate: The nominal exchange rate is the amount of domestic currency needed to purchase foreign currency. example: if the exchange rate is £ 1 = $ 2, then a British can exchange one pound for two dollars in the world market. Similarly, an American can exchange two dollars to get one pound.

But the PPP inflation and exchange rate may differ from the market exchange rate because of poverty, tariffs, and other transaction costs. PPP exchange rates are widely used when comparing the GDP of different countries.

But we know that Purchasing power parity (PPP) is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. It states that the price levels between two countries should be equal.This means that goods in each country will cost the same once the currencies have been exchanged.

Example: if the price of a Coca Cola in the UK was 100p, and it was $1.50 in the US, then the GBP/USD exchange rate should be 1.50 (the US price divided by the UK’s) according to the PPP theory.

The price level in country one divided by the price level in country two equals the exchange rate between the two countries.Thus, the UK price level divided by the American price level gives the UK-to-American exchange rate. Any violation of this equation puts pressure on exchange rates until the equation reaches equilibrium.PPP does not affect exchange rates in the short term. Rather, economic and political news, such as changes in the money supply or interest rates, drive short-term exchange rates. PPP does have a long-term impact on exchange rates because long-term economic trends help determine inflation, and therefore change exchange rates.

Although PPP doesn’t directly influence prices, it does show global experts how healthy various economies are.

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