Question

Imagine that the economy of Germany finds itself in the following situation: the government budget has a surplus of 1% of Germany’s GDP; private savings is 20% of GDP; and physical investment is 18% of GDP.

a. Based on the national saving and investment identity, what is the current account balance?

b. If the government budget surplus falls to zero, how will this affect the current account balance?

Short answer

a. 3%

b. 2%

Step-by-step solution

Step1. Introduction

The savings-investment identity is-

Assuming a trade surplus,

X-M= S + T-G - I

Let us assume,

GDP=100

Budget Surplus= T-G= 1

Pvt savings= S= 20

Investments= I= 18

Step2. Explanation

a.

Current account balance (trade surplus)=

20+1-18= 3

i.e. 3%

b. If government surplus falls to 0, current account balance falls too.

It becomes-

20+0-18= 2

i.e. 2%