Using the data given in the question:
b. Calculate the official settlements balance for Rijkdom. Did the central bank of
Rijkdom experience a decrease or an increase in its foreign reserve holdings?
Explain this in terms of the figure you calculated and what the official settlements
balance measures.
Answer: FA = official settlements balance + nonreserve financial account
c. Calculate net factor income from abroad for Rijkdom. How much did Rijkdomian
factors abroad earn?
Answer: From the definition of the current account:
Substituting the data from the question:
We calculated NFIA previously and, from the data, we know IMFS = $150
million:
d. Is Rijkdom a net lender or a net borrower? Explain how you know.
Answer: Rijkdom is a net lender because it has a current account surplus. This
5. Use the information from Question 4 to answer the following questions.
a. Calculate Rijkdom’s GDP, GNI, and GNDI.
Answer: From the GDP identity:
From the GNI identity:
From the GNDI identity:
b. Calculate investment for Rijkdom.
Answer: From the definition of GNE:
c. Calculate Rijkdom’s national savings and private savings.
Answer: From the current account identity: S = I + CA = 2,600 + 1,000 = $3,600
d. Suppose that valuation effects imply a capital gain of $220 million on external
wealth. Calculate the change in Rijkdom’s external wealth. Based on these data,
discuss the three sources of the change in external wealth. Which one appears to
be most important for Rijkdom? Explain.
Answer: Change in external wealth = valuation effects + CA + KA
6. This question requires that you obtain data from the Federal Reserve Economic
Database (FRED) (http://research.stlouisfed.org/fred2/). On this page, you can locate
GDP data and then import/ export these data. View the current account.
a. Looking at the time series plot provided by FRED, what has happened to the U.S.
current account over time? Compare the U.S. experience in the 1960s with that
since 1990.
Answer: Data and graphs that answer this question are included in the Excel
workbook for this chapter. The graph below was produced by FRED.
b. Looking at the current account identity, what are the possible sources of the
dramatic change in the U.S. current account observed over the last 10 years?
Answer: We can use the current account identity combined with the definitions of
savings (national, private, and government):
c. In the figure, the recession dates are shaded. What happened to the U.S. current
account during the last two U.S. recessions in 2001 and 2008–2009? Looking at
the current account identity, what are the possible reasons that the current account
would behave this way during recessions?
Answer: During the 2001 recession, the current account increased (decreasing
7. During the mid- to late 1990s, the United States experienced an increase in
investment, and the U.S. government budget went from a deficit to budget surplus.
All else equal, how would this affect the U.S. current account? Explain why, citing
how this budget surplus affects domestic savings relative to domestic investment.
Answer: We can use the current account identity combined with the definitions of
savings (national, private, and government):
8. Suppose the government is considering a tax policy that will reduce taxes by $100. In
the economy, households consume 80% of each additional dollar earned. Assume that
the tax cut has no effect on GDP(Y).
a. How will this tax cut affect consumption?
b. Calculate the change in private savings.
Answer: From the definition of private savings:
c. Calculate the change in government savings and national savings.
Answer: From the definition of government savings:
d. What will happen to the current account as a result of this policy?
Answer: From the current account identity:
e. How would your previous answers change if we assume Ricardian equivalence?
Answer: According to Ricardian equivalence, when households observe the tax
9. Evaluate the validity of each of the following statements. You should support your
answer with relevant definitions/equations.
a. When there are no domestic taxes in an open economy, GNI is equal to GNDI.
Answer: False. A country can still receive or give unilateral transfers, even if it
has no domestic taxes:
b. When the government runs a budget deficit, the current account must also be in
deficit.
Answer: False. Combining the current account identity with the definition of
savings:
c. In a closed economy, GNE is equal to GNI.
Answer: True. From the GNI identity:
d. In an open economy, if there is no NFIA, then GNE is equal to GNI.
Answer: False. From the GNI identity:
e. In an open economy with no taxes, government saving is equal to private saving.
Answer: False. The definitions of private and government savings are
f. In a closed economy, domestic saving is equal to domestic investment.
Answer: True. From the current account identity:
g. In an open economy, if the economy has a current account surplus, this implies
that domestic savings exceeds domestic investment.
Answer: True. From the current account identity:
10. Show (using the credit/debit tables) how each of the following would affect the U.S.
BOP. Your records should include a description of the transaction being recorded,
which specific account is affected (e.g., exports [EX], home financial account assets
[EXHA], etc.), and the accompanying credit/debit entry.
a. A U.S. airplane manufacturer imports $600,000 in parts from a Canadian firm. It
uses a U.S. bank account to pay for the parts.
Answer:
Description
BOP Account
Account (detail)
Credit/Debit
Import of airplane parts from
Canada
CA (↓)
−IMFS (↑), NFIA
(↓)
−$600,000
Canadian firm’s claim on U.S.
deposits
FA (↑)
+EXH
A
(↑)
+$600,000
b. The Bank of England (U.K. central bank) buys $2 million in U.S. Treasury bonds
from an American securities firm.
Answer:
Description
BOP
Account
Account
(detail)
U.K. ownerships of U.S. assets increases
FA (↑)
+EXH
A
(↑)
American securities firm’s claim on
Bank of England deposits
FA (↓)
−IMF
A
(↑)
c. An Italian tourist charges $400 to his MasterCard (issued by an Italian bank) for a
hotel room in New York City.
Answer:
Description
BOP
Account
Account
(detail)
Export of hotel room from the United
States to Italy
CA (↑)
+EX (↑), TB
(↑)
U.S. hotel claim on Italian MasterCard
FA (↓)
−IMF
A
(↑)
d. A Chinese catering company purchases $30,000 in helium tanks from a U.S.
welding firm. The Chinese catering company uses deposits from a bank in China.
Answer:
Description
BOP
Account
Account
(detail)
Export of helium from the United
States to China
CA (↑)
+EX (↑), TB
(↑)
U.S. welding firm’s claim on Chinese
deposits
FA (↓)
−IMF
A
(↑)
e. A French firm forgives a $250,000 loan to an oil refinery located in Louisiana
following a hurricane.
Answer:
Description
BOP
Account
Account
(detail)
French grant of debt relief to U.S.
firm
KA (↑)
+KA
IN
(↑)
Decrease in U.S. external liabilities
FA (↓)
+EXH
A
(↓)
f. The United States donates $8 million in medical and food supplies to Lebanon
following a month-long war.
Answer:
Description
BOP
Account
Account (detail)
Relief supplies from United States
to Lebanon
CA (↑)
+EX (↑), TB (↑)
U.S. charitable gift to Lebanon
CA (↓)
−UT
OUT
(↑), NUT
(↓)
11. Consider the economy of Aureus. In Aureus, domestic investment is $300 million and
its residents earned $10 million in capital gains during 2006. Residents of Aureus
purchased $150 million in new foreign assets during the year and foreigners
purchased $120 million in Aureus assets. Assume the valuation effects total $1
million in capital gains.
a. Calculate the change in domestic wealth in Aureus.
Note, we need to assume a value for the capital account. We will assume KA = 0
in the transactions below.
b. Calculate the change in external wealth for Aureus.
c. Calculate the total change in wealth for Aureus.
Answer: The change in total wealth is
d. Calculate domestic savings for Aureus.
Answer: To calculate national savings, note the change in total wealth is
e. Calculate Aureus’ current account. Is the CA in deficit or surplus?
Answer: Using the current account identity:
f. Explain the intuition for the CA deficit/surplus in terms of savings in Aureus,
financial flows, and its domestic/external wealth position.
Answer: Aureus experienced a $310 million increase in its domestic wealth while