The current account surplus is a decreasing function of disposable income and a decreasing function of...

The current account surplus is a decreasing function of disposable income and a decreasing function of the real exchange rate, why? Please explain using graphs and a real-life example.

Expert Solution

Current account surplus is the difference of saving and investment. When saving exceeds investment, current account is in surplus and when saving falls short of investment, current account is in deficit. When currency appreciates, that is, real exchange rate rises, Investment rises and saving fall so that S - I or current account surplus is reduced. This shows that current account surplus is a decreasing function of real exchange rate

Current account surplus is also called trade balance or net exports. It is the excess of exports over imports. Imports are a function of disposable income and so when disposable income rises, imports are increased. This reduces net exports and thus, the current account surplus. This shows that current account surplus is a decreasing function of disposable income

Below is an example where a decline in the exchange rate (depreciation) raises saving above investment so there is an increase in net exports and results in a current account surplus.

A real life example comes from India's current account where it registered a surplus of 4250 INR in Jan 2007 when India had economic recession and a lower disposable income. This decreased the demand for imports and so there was a current account surplus

Rahul Sunny answered 1 year ago

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