How Economics Affects Nations

Economics Questions
1. What is meant by “twin deficits”? Use this relationship between GNE and GNDI to explain your answer
Twin deficits take into account a circumstance where an economy is facing both a fiscal deficit as well as a deficit on the current account for the nation’s balance of payments. Therefore, the nation is facing both trade deficits and government budget deficits. This can elucidate the relationship between national income (GNDI) and the national expense (GNE). Notably,
GNDI = GNE + CA (current account)
GNDI > GNE if and only if CA > 0 and this is indicative of a surplus in the current account
GNDI < GNE if and only if CA < 0 and this is indicative of a deficit in the current account
2. Give an intuitive explanation that captures the relationship between the current account position (surplus or deficit) and role of the country as a net borrower or lender. How may this relationship generate wealth effects altering the later Current Account?
A surplus in the current account is a positive variance between the savings and investment of a nation. Such a surplus is indicative of a country being a net lender to the entire world. On the other hand, a deficit in the current account is a negative variance between the savings and investment of a nation. Such a deficit is indicative of a nation being a net borrower. This relationship generates wealth effect altering the later current account because it causes a negative or positive balance. Notably, developed nations such as the U.S run a positive or surplus current account whereas developing nations run a negative or deficit current account (Investopedia, n.d.).
3. What role do exchange rates play in the net external wealth of a country? Illustrate by explaining what an exchange rate appreciation can do to a country holding an asset denominated in foreign currency
Exchange rates play a significant role in the net external wealth of a nation owing to their relationship with net capital flows and net capital gains. Exchange rate is fundamental to economic management and price stability in a nation. Attractive exchange rates give rise to greater foreign investor flows, which increase the wealth of a country. Notably, an exchange rate appreciation gives rise to an increase in net investment capital flows. In global trade, currency appreciation causes a nation’s exports to become more costly for the citizens of other nations if exporters in that nation can escalate the prices at which they retail their goods to foreign consumers. In particular, if the exporters lack the capacity to increase the prices of their sales as a result of competition, it implies that their profits diminish for the reason that the cost of production that has its denominations in the domestic currency, increases in relation to the revenues whose denominations are set in the foreign currency. The deterioration in profits implies that there is a deteriorating in exportation (Caprio, 2012).
4. Assume a nation has an output level of 150. Suppose there is a sudden temporary drop in GDP by 16%. How will the trade balance evolve if this country has access to global financial markets with an interest rate of 5%?
The decrease in the GDP of the economy will cause a decrease in the interest rates of the nation. The main advantage of this to the trade balance is that it causes an increase in the level of investment, an increase in the demand for domestic goods and increase in output. Therefore, there will be a positive trade balance.
5. In theory, there are three primary benefits to financial globalization. Briefly explain each
Financial globalization, delineated as international linkages by means of cross-border financial flows, has come to be progressively more pertinent for emerging markets as they assimilate financially with the rest of the world (Yeyati and Williams, 2014). The benefits of financial globalization are as follows:
1. International risk sharing
When the countries across various borders conduct financial transactions, the financial and economic risk that is experienced is shared by all nations and not just one of them.
2. Reduce macroeconomic volatility
There is decreased macroeconomic susceptibility and volatility for the reason that there is the integration of numerous nations across the globe and therefore economic changes do not just impact a nation or a region but the world at large.
3. Foster economic growth
Through financial globalization, there is an increase in implementation of the right policies together with accessibility in capital markets which is a powerful means for increasing growths in economies (Cline, 2010).
6. Explain what J-curve is, and why it occurs. What problems may this cause if a country attempts to devalue (weaken) their exchange rate to reduce a current account deficit?
A J-curve is perceived in economy when the trade balance of a nation at the outset worsens subsequent to a devaluation or depreciation of its currency. Imperatively, the problems that this may cause in a nation include: attempts to weaken their exchange rate, so as to decrease a current account deficit is that when the exchange rate was higher in the first place, it gives rise to more expensive imports and exports that have lower value giving rise to a greater initial deficit or a lesser surplus (Investopedia, n.d.).










References
Caprio, G. (Ed.). (2012). The evidence and impact of financial globalization. Academic Press.
Cline, W. R. (2010). Financial globalization, economic growth, and the crisis of 2007-2009. Peterson Institute.
Investopedia. (n.d.). Current Account. Retrieved from: https://www.investopedia.com/terms/c/currentaccount.asp
Investopedia. (n.d.). J-Curve Effect. Retrieved from: https://www.investopedia.com/terms/j/j-curve-effect.asp
Yeyati, E. L., & Williams, T. (2014). Financial globalization in emerging economies: Much ado about nothing?. economía, 14(2), 91-131.