ANALYTICAL PROBLEMS
1. Explain how each of the following transactions would enter the U.S. balance of payments accounts. Discuss only the transactions described. Do not be concerned with possible offsetting transactions.
a. The U.S. government sells F-16 fighter planes to a foreign government.
b. A London bank sells yen to and buys dollars from a Swiss bank.
c. The Federal Reserve sells yen to and buys dollars from a Swiss bank.
d. A New York bank receives the interest on its loans to Brazil.
e. A U.S. collector buys some ancient artifacts from a collection in Egypt.
f. A U.S. oil company buys insurance from a Canadian insurance company to insure its oil rigs in the Gulf of Mexico.
g. A U.S. company borrows from a British bank.
2. For each transaction described in Analytical Problem 1 that by itself changes the sum of the U.S. current account balance, CA, and the U.S. financial account balance, FA, give an example of an offsetting transaction that would leave CA + FA unchanged.
3. A large country imposes capital controls that prohibit foreign borrowing and lending by domestic residents. Analyze the effects on the country's current account balance, national saving, and investment, and on domestic and world real interest rates. Assume that, before the capital controls were imposed, the large country was running a financial account surplus.
4. The text showed, for a small open economy, that an increase in the government budget deficit raises the current account deficit only if it affects desired national saving in the home country. Show that this result is also true for a large open economy. Then assume that an increase in the government budget deficit does affect desired national saving in the home country. What effects will the increased budget deficit have on the foreign country's current account, investment in both countries, and the world real interest rate?
5.
How would each of the following affect national saving, investment, the current account balance, and the real interest rate in a large open economy?a. An increase in the domestic willingness to save (which raises desired national saving at any given real interest rate).
b. An increase in the willingness of foreigners to save.
c. A temporary increase in foreign government purchases.
d. An increase in foreign taxes (consider both the case in which Ricardian equivalence holds and the case in which it doesn't hold).
6. Analyze the effects on a large open economy of a temporary adverse supply shock that hits only the foreign economy. Discuss the impact on the home country's national saving, investment, and current account balance—and on the world real interest rate. How does your answer differ if the adverse supply shock is worldwide?
7. The chief economic advisor of a small open economy made the following announcement: “We have good news and bad news: The good news is that we have just had a temporary beneficial productivity shock that will increase output; the bad news is that the increase in output and income will lead domestic consumers to buy more imported goods, and our current account balance will fall." Analyze this statement, taking as given that a beneficial productivity shock has indeed occurred.
8. The world is made up of only two large countries: Eastland and Westland. Westland is running a large current account deficit and often appeals to Eastland for help in reducing this current account deficit. Currently, the government of Eastland purchases $10 billion of goods and services, and all of these goods and services are produced in Eastland. The finance minister of Eastland proposes that the government purchase half of its goods from Westland. Specifically, the government of Eastland will continue to purchase $10 billion of goods, but $5 billion will be from Eastland and $5 billion will be from Westland. The finance minister gives the following rationale: “Both countries produce identical goods so it does not really matter to us which country produced the goods we purchase. Moreover, this change in purchasing policy will help reduce Westland's large current account deficit." What are the effects of this change in purchasing policy on the current account balance in each country and on the world real interest rate? (Hint: What happens to net exports by the private sector in each country after the government of Eastland changes its purchasing policy?)
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