Question 1

Which of the following best describes the relationship between the current account and the financial account in a country's balance of payments?

Accepted Answer

A current account surplus is always matched by a financial account deficit of equal magnitude.

Question 2

Suppose the U.S. government sells F-16 fighter planes to a foreign government. How is this transaction recorded in the U.S. balance of payments?

Accepted Answer

As a credit in the current account (export of goods) and a credit in the financial account (capital inflow if paid with foreign assets).

Question 3

If a small open economy experiences a temporary adverse supply shock that reduces its output, what is the most likely effect on its net foreign lending?

Accepted Answer

Net foreign lending will decline because national saving falls.

Question 4

In a small open economy, if the government increases its budget deficit and this reduces desired national saving, what happens to the current account balance?

Accepted Answer

The current account balance decreases (becomes more negative or less positive).

Question 5

A U.S. oil company buys insurance from a Canadian insurance company to insure its oil rigs in the Gulf of Mexico. How is this transaction recorded in the U.S. balance of payments?

Accepted Answer

As a debit in the current account (import of services).

Question 6

Suppose a small island nation has $$1,000,000 in annual coconut output, owns 500$$,000 in foreign bonds earning 5% interest, and consumes $1,025,000 per year. What is its current account balance?

Accepted Answer

$25,000 surplus

Question 7

Which of the following best explains why the United States can sustain a large current account deficit without immediate economic crisis?

Accepted Answer

Because the U.S. is a safe destination for foreign investment and has high wealth relative to its net foreign debt.

Question 8

In a large open economy, what is the effect of an increase in the domestic willingness to save on the world real interest rate and the current account balance?

Accepted Answer

The world real interest rate falls and the current account balance increases.

Question 9

If a country’s net foreign assets increase, which of the following must be true?

Accepted Answer

The country is running a current account surplus.

Question 10

Suppose the Home country increases government purchases by $50, financed by an equal increase in taxes (no change in deficit). In a large open economy, what is the likely effect on the world real interest rate?

Accepted Answer

The world real interest rate will remain unchanged because national saving is unchanged.

Question 11

A country imposes capital controls that prohibit foreign borrowing and lending by domestic residents. If the country was previously running a financial account surplus, what is the most likely effect?

Accepted Answer

Domestic real interest rates will rise, and the current account balance will move toward zero.

Question 12

Which of the following is NOT included in official reserve assets?

Accepted Answer

Shares of domestic companies held by citizens

Question 13

If the U.S. current account deficit increases, which of the following must also occur, all else equal?

Accepted Answer

The U.S. financial account surplus increases.

Question 14

Suppose a U.S. collector buys ancient artifacts from Egypt. How is this transaction recorded in the U.S. balance of payments?

Accepted Answer

As a debit in the current account (import of goods).

Question 15

Which of the following equations correctly represents the relationship between national saving $$(S)$$, investment $$(I)$$, and the current account $$(CA) in an $$open economy?

Accepted Answer

$$S = I + CA$$

Question 16

If a country has a current account deficit and its government budget deficit increases, under what condition will the current account deficit also increase?

Accepted Answer

If the increase in the government budget deficit reduces desired national saving.

Question 17

Which of the following best describes the effect of a temporary increase in foreign government purchases on the world real interest rate in a large open economy?

Accepted Answer

The world real interest rate rises.

Question 18

A London bank sells yen to and buys dollars from a Swiss bank. How is this transaction recorded in the U.S. balance of payments?

Accepted Answer

It is not recorded, as it does not involve the U.S.

Question 19

If the Federal Reserve sells yen to and buys dollars from a Swiss bank, what is the effect on U.S. official reserve assets?

Accepted Answer

U.S. official reserve assets decrease.

Question 20

Which of the following is a plausible reason why a country might have a current account deficit but bilateral trade surpluses with some countries?

Accepted Answer

Because the current account is the sum of all bilateral balances, and surpluses with some countries can be offset by larger deficits with others.

Chapter 5: Saving and Investment in the Open Economy – Study Notes

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