Question

In a small open economy, starting from a position of balanced trade, if the government increases domestic government purchases, this produces a tendency toward a trade ______ and ______ net capital outflow.
A) deficit; negative
B) surplus; positive
C) deficit; positive
D) surplus; negative

Answer 1

Answer:

Option A is correct.

deficit; negative

Explanation:

In a small open economy, starting from a position of balanced trade, if the government increases domestic government purchases, this produces a tendency toward a trade deficit and negaive net capital outflow.

This corresponds to the concept of twin deficits where a budget deficit that results from increased government purchases, also results in current account deficit. Since trade deficit implies negative NX there is a negative NCO.