Explain how the change in the financial account balance will likely impact long-run economic growth?
The correct answer and explanation is:
The change in the financial account balance can significantly influence long-run economic growth. The financial account records a country’s net capital inflows and outflows, including foreign investments, loans, and purchases of assets. A positive financial account balance means that a country is attracting more foreign capital than it is sending abroad, while a negative balance indicates capital outflows exceed inflows.
When the financial account balance increases due to higher capital inflows, it often means more foreign investment in the domestic economy. This inflow of funds can be used to finance domestic investment projects, such as building infrastructure, expanding businesses, and improving technology. These investments enhance the country’s productive capacity, leading to increased output and economic growth over time.
Additionally, foreign capital inflows can improve the availability of credit and lower interest rates, encouraging more domestic investment. Access to foreign funds can also facilitate technology transfer and improve managerial expertise, further boosting productivity.
On the other hand, a decrease in the financial account balance or capital outflows can reduce the amount of funds available for domestic investment. This reduction may slow the growth of capital stock, limiting improvements in productivity and economic expansion. If capital leaves the country in large amounts, it can cause currency depreciation, inflation, and higher borrowing costs, which negatively impact long-term growth prospects.
However, the impact depends on the nature of capital inflows. Short-term speculative investments may create volatility without contributing much to sustainable growth. In contrast, long-term investments, such as foreign direct investment, tend to have more positive effects on economic growth.
In summary, an increase in the financial account balance, reflecting higher foreign investment, usually supports long-run economic growth by providing capital for investment, improving productivity, and facilitating technology transfer. Conversely, a decline can constrain investment and slow growth. The quality and stability of capital flows also matter for sustaining growth over time.