Question
In: Economics
Compare two countries one big economy and one small economy. Suppose that both economies have the...
Compare two countries one big economy and one small economy. Suppose that both economies have the same percentage of Current account deficit to GDP ratio.
a) Why do you think current account deficit be an economic problem for these countries?,
b) Would it be more problematic in small or big economies? Why?
Solutions
Expert Solution
a) A current account deficit refers to the difference between the value of exports and the value of imports plus the net factor payments from abroad. A high current account to gdp ratio means that the country is unable to pay for its exports through it's import receipt. It can be said that such a country is overspending on its exports and may run into a debt due to borrowing to pay for its exports. In the long run, such indebtedness is not good for the country's economy and may lead to devaluation of its currency. Therefore, current account deficit is a problem to countries.
b) The country with a large economy will be able to fund its imports in the long run since its trade share is quite high in the world economy. This is why large developed economies do well despite having large current account deficits, while small poor economies run into huge debts and become further impoverished. Therefore, the current account deficit is more problematic for the small economy compared to the big economy.
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