Question

If a country runs a surplus in financial account, its current account has a deficit. True, false, or uncertain? Explain.

Answer 1

The statement "if a country runs a surplus in financial account, its current account has a deficit" is cent percent true. This can be explained as follows:-

A surplus on the financial account means that there are more investment funds flowing into the country than flowing out. Inward investment may help create jobs and boost growth of an economy, but an investor investing in an economy expects a return. Therefore, a surplus on the financial account will lead to outflows of interest and dividends in the future, thus affecting/causing deficit in the current account. Further any inflow of funds may exert upward pressure on the exchange rates, as the demand for the domestic currency will increase. This will adversely affect the current account if the increase in export prices makes exports less attractive. So it can be concluded that surplus in financial account will cause a deficit in current account.