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International Economics

Terms in this set (35)

Depreciation of the currency - If domestic consumers demand more imports than foreigners demand of the home country's exports, then the value of the domestic currency will fall. A weaker currency makes imported raw materials more expensive and can contribute to cost push inflation.

Increased foreign ownership of domestic assets - A deficit in the current account means a surplus in the financial account. This means foreigners own more of the home country's assets than domestic investors own of foreign assets. Such foreign ownership of domestic assets may pose a threat to the economic freedom of the deficit country.

Higher interest rates - A country may try to strengthen the currency by raising interest rates to attract foreign capital to the country. A higher interest rate will negatively effect domestic investment by firms, slowing growth in the nation's capital stock over time.

Increased indebtedness - Countries that have current account deficits will often finance them by running financial account surpluses. The easiest way to do this is by acquiring debt, selling bonds. However as a country accumulates debt, lenders may lose confidence in the country's ability to pay it back. Countries must pay interest on their debt, which reduces the governments ability to spend on domestic projects. A current account deficit that becomes too extreme can be unsustainable.

A current account deficit is an indication of a lack of competitiveness in the export sector, therefore a weaker currency may not actually increase demand by that much, and may actually lead to cost-push inflation.