Question

Please explain your answer. Thanks so much!!

Suppose that you had to explain to a person (who is not an economist) why a current account deficit must be accompanied by a financial or capital account surplus. What would you say?

Answer 1

A country could have a current account deÖcit and a balance of payments surplus
at the same time if the Önancial and capital account surpluses exceeded the current account
deÖcit. Recall that the balance of payments surplus equals the current account surplus plus
the Önancial account surplus plus the capital account surplus. If, for example, there is a
current account deÖcit of $100 million, but there are large capital ináows and the capital
account surplus is $102 million, then there will be a $2 million balance of payments surplus.
This problem can be used as an introduction to intervention (or lack thereof) in the
foreign exchange market, a topic taken up in more detail in Chapter 17. The government
of the United States did not intervene in any appreciable manner in the foreign exchange
markets in the Örst half of the 1980s. The ìtextbookî consequence of this is a balance
of payments of zero, while the actual Ögures showed a slight balance of payments surplus
between 1982 and 1985. These years were also marked by large current account deÖcits.
Thus, the Önancial ináows into the United States between 1982 and 1985 exceeded the
current account deÖcits in those years