CFA CFA Level 1 Current Account example: why increase in savings = decrease in trade deficit?


Current Account example: why increase in savings = decrease in trade deficit?

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    • Avatar of pcunniffpcunniff
        • CFA Level 1

        Hello all – I get confused on this topic and understand (x-m)= S-I + (T-G). Maybe the explanation just confuses me here.

        A decrease in savings should increase the left side of the equation.  So how does a decrease in a deficit (more imports than exports) result from decreasing savings relative to investment? I would think this would increase it but perhaps someone could explain better.

        Thanks in advance as this trips me up every time.

        Other things equal, which of the following is most likely to decrease a country’s trade deficit?

        1. Increase its capital account surplus.
        2. Decrease expenditures relative to income.
        3. Decrease domestic saving relative to domestic investment.

        Explanation: An improvement in a trade deficit requires that domestic savings increase relative to domestic investment, which would decrease a capital account surplus. Decreasing expenditures relative to income means domestic savings increase. Decreasing domestic saving relative to domestic investment is consistent with a larger capital account surplus (an increase in net foreign borrowing) and a greater trade deficit. (LOS 18.j)

        mikey voted up
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        Accepted answer

        The question is worded in a confusing manner (aren’t they all).

        Decreasing a country’s trade deficit means increasing exports OR reducing imports. (x-m)↑

        Increasing domestic saving relative to domestic investment, (S-I)↑, either means:

        • Increasing domestic savings, which means people are spending less, therefore reducing imports.
        • Reducing domestic investment, which means less capital inflow from abroad.

        All other factors equal, either will result in an increase in the trade balance (x-m).

        The equation you cited also corresponds to this:

        (x-m)= (S-I) + (T-G)


        • X=exports
        • M=imports
        • S=domestic saving
        • I=investment spending
        • T=taxes
        • G=government spending

        So if (x-m)↑, (S-I)↑.

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