The current account surplus is one of the main indicator in an open economy model. Using...

The current account surplus is one of the main indicator in an open economy model. Using appropriate diagrams, explain the effect of increase in the world real interest on current account surplus.

Expert Solution

Current account surplus is the exceeding of credit over debit, where the revenue exceeds the expenditure. Current account surplus is the situation were the greater value of export of goods and services. Thus the country have surplus over foreign exchange. The high level export will be increased the domestic employment level. Lowering import will increase the demand for domestic goods in the market. A falling interest rate will induce the investment rate and production level. Lowering interest rate will leads to depreciation of the domestic currency and this will make export cheaply and import expensively. This will increase the current account. The rising global interest rate will help the consumer save more and this will reduce the investment rate.
If the world interest rate raises the domestic investment rate. If the domestic interest rate rises the borrowing will be expensive. This affects the current account surplus. The current account will leads to current account deficit. The higher interest rate will appreciate the value of domestic current and import become expensive and export become cheaply. On the other hand, the rise in interest rate will reduce the level of disposable income and also reduce the consumption level. If there is fall in investment rate it will affect the domestic production sector. There is high level dependence over foreign country through cheap import. Thus the national GDP fall down. This fall in production will reduce the price level also. But the level of real output remain the same.

Rahul Sunny answered 2 years ago

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