Question

Holding national savings constant, an increase in domestic investment must be associated with:

(a) an increase in the current account and, over time, a decline in net foreign assets.
(b) a fall in the current account and, over time, a fall in net foreign assets.
(c) an increase in the current account and, over time, a rise in net foreign assets.
(d) a fall in the current account and, over time, a rise in net foreign assets.
(e) None of the above.

Answer 1

An increase in domestic investment with constant national savings is associated with a fall in the current account and a decrease in net foreign assets over time.

Step-by-step explanation:

Holding national savings constant, an increase in domestic investment must be associated with a choice (b) a fall in the current account and, over time, a fall in net foreign assets. The national saving and investment identity dictates that if investment (I) rises while national savings (S) and the government budget surplus (T - G) are unchanged, the trade deficit (M - X) must increase to maintain the equality of S + (M - X) + (T - G) = I. Therefore, this increase in domestic investment implies greater reliance on foreign financial capital, resulting in a larger trade deficit and a reduction in the nation's net foreign assets over time.