How Economics Affects Nations Essay

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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.

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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.….....

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