Question

To reduce a current account deficit, a country must increase its private saving, reduce domestic investment, or cut its government budget deficit. Nowadays, some people recommend restrictions on imports from China (and other countries) to reduce the American current account deficit.
a. How would higher U.S. barriers to imports affect its private saving, domestic investment, and government deficit? Please explain.

Answer 1

Answer:

Current account deficit occurs when imports of an economy exceeds to that of its exports.

Explanation:

In order to reduce the current account deficit raising import barriers results in increase in private savings and fall in the demand of foreign products.

Lower level of imports results less outflow of foreign exchange. This will help in strengthening the currency and reduce the cost of imports

However this may not be the situation in a highly globalized economy.

Higher savings would result in increased investment in the domestic economy as the saving identity concept states the amount of money saved equates to the amount of money invested. Hence domestic investment increases.

Moreover as the current account deficit falls government does not need to borrow to finance its Current account deficit. Therefore government deficit falls if we go by the rules of thumb.