Schweser pg 86 Figure 2 says expansionary policy leads to current account deficit so a contractionary policy should do the opposite i.e. lead to a current surplus. So why does the answer to the following question seems to be backwards for the current account:
Question
An economy is in long-run equilibrium and the values of its imports and exports are equal. If the growth rate of the money supply is unexpectedly decreased, what are the most likely effects on real GDP and the country’s current account balance?
Real GDP / Current account
A) Increase / Suplus
B) Decrease / Deficit
C) Decrease / Surplus
——————————————————————————–
Click for Answer and Explanation
Real GDP is likely to decrease as higher real interest rates (resulting from slower money supply growth) reduce business investment and consumers’ purchases of durable goods. The current account initially moves into surplus as decreasing real GDP reduces domestic incomes and the demand for imports. However, higher real interest rates will cause the domestic currency to appreciate, making imports less expensive and exports more expensive. Thus imports are likely to increase while exports decrease, which should more than offset the initial effect and result in a current account deficit.
Question
An economy is in long-run equilibrium and the values of its imports and exports are equal. If the growth rate of the money supply is unexpectedly decreased, what are the most likely effects on real GDP and the country’s current account balance?
Real GDP / Current account
A) Increase / Suplus
B) Decrease / Deficit
C) Decrease / Surplus
——————————————————————————–
Click for Answer and Explanation
Real GDP is likely to decrease as higher real interest rates (resulting from slower money supply growth) reduce business investment and consumers’ purchases of durable goods. The current account initially moves into surplus as decreasing real GDP reduces domestic incomes and the demand for imports. However, higher real interest rates will cause the domestic currency to appreciate, making imports less expensive and exports more expensive. Thus imports are likely to increase while exports decrease, which should more than offset the initial effect and result in a current account deficit.