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FRM Part I · FRM Exam Part I · Foreign Exchange Markets

A country's current account deficit is 4% of GDP. Its private saving is 18% of GDP, private investment is 20% of GDP, and there is no statistical discrepancy. Using the identity CA = (S_private − I) + (T − G), what is the government budget balance as a percentage of GDP?

The government runs a budget deficit of 2% of GDP. The current account of −4% equals the private saving-investment gap of −2% plus the budget balance, so the budget balance must be −2%, meaning a deficit. This is the twin deficits identity.

  1. ADeficit of 2% of GDPCorrect
  2. BSurplus of 2% of GDP
  3. CDeficit of 6% of GDP
  4. DSurplus of 6% of GDP

Explanation

CA = −4 = (18 − 20) + (T − G) = −2 + (T − G). So T − G = −2, a budget deficit of 2% of GDP. A surplus of 2% results from a sign error. A 6% deficit results from adding rather than subtracting the private gap (−4 − 2). Checking: −2 + −2 = −4.

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