Econ Assignment - Essay Example

The fall in income earned by the consumers in the U.S. could be viewed as its impact on the current account. It is estimated that almost 10% of every Dollar spent by U.S. customers is on purchase of imported goods (Kaplan) however as the income falls in the U.S. the customers demand for imported goods will surely be affected. As consumers spend less on goods and services the proportion they spend on imports will reduce. The effect would be rising current account surplus and positive balance of payments.

If the inflation in the foreign country increases it will have an upward effect on the cost of production in that country and making its exports to the U.S. more expensive than its imports. This suggests that U.S. consumers would end up paying more for imported goods that will provoke them to switch over to less costly goods produced domestically (Kaplan). This can also have a reverse effect on the U.S. exports thereby increasing the current account surplus with that country in the short run till inflation remains comparatively higher in the foreign country.

The interest rate fall in the U.S. has its impact on the capital account of the country. The decline in interest rates in the U.S. implies the reduction in the return on savings and relative return in the financial markets of the U.S. This suggests that foreign investors will be reluctant to invest in the financial markets who will be seeking greater returns in other foreign markets. This makes the local financial markets unattractive and may lead to outflow of funds through capital markets. The exchange rate is the relative price of a currency against other currencies.

The exchange rate is typically driven by the demand and supply of the currency. As consumers will use less of the local currency due to fall in their income it suggests a lower demand for it as less money will be spent on imported goods and services therefore its supply dampens. The net result is decline in the exchange rate against