Economics Critical Thinking Sample

Question 1

The articles assess the level of foreign debt of the U.S.A economy and its sustainability. The authors are optimistic that the U.S.A economy will continue to grow despite the high foreign debt level. The authors debunk the arguments by doubters as to why the current foreign debt of the US is unsustainable. According to critiques, the high foreign debt coupled with excessive government spending and a low domestic savings rate is likely to reduce the attractiveness of the US as an investment hub. Investors would look for alternative investments and reduce additional investments in the US that will consequently cause panic and result in herding effect as foreign investors’ troop out of the US. This will trigger a depreciating of the dollar and a drastic increase in interest rates that would result in an economic crisis in the U.S.A and the entire world. Critiques give examples of economies that have collapsed due to the burden of excessive foreign debt in order to justify their prophecy.

Question 2

It is caused by a negative Net International Investment Position (NIIP). Foreign investments in the US are higher than US investments in other countries. For instance, it 2004 foreign claim in the US was worth US $ 10.7 trillion compared to US foreign claim of US $ 7.9 trillion creating a deficit of US $2.6 trillion. The authors attribute to the attractiveness of US as an investment destination and the increase in world wealth.

Question 3

It can finance itself by taking more debt as long as the debt is sustainable. The government can create a well regulated financial market and periodically intervening through monetary policy to ensure that the US dollar remain stable. In addition, maintaining entrepreneurial edge will attract both foreign and domestic investments into productive sectors which will consequently generate wealth.
The exchange market, interest rate and goods market can bring about restoration of the balance of payment. The US dollar will depreciate against other currencies and the prices of goods will increase. The US dollar remains the dominant world currency and all US debts are denominated in dollars. Therefore, a depreciating US dollar will reduce the real value of foreign debt and consequently reducing the deficit. In addition, rising interest rates will reduce the prices of US debt securities hence reducing the net value of foreign debt.
The US government can use direct intervention in the foreign exchange market to prevent a drastic decline in the dollar that may cause panic. In addition, it may purchase back some of its debt securities to prop up prices to avoid drastic price decline.

Question 4

Government spending will worsen the current account deficit. This is because increasing government spending requires issuing additional government bonds that are likely to end up in the hands of foreign investors. In addition, it will crowd out domestic firms forcing them to seek funds from foreign investors or in foreign financial markets thus increasing the current account deficit.
On the other hand, reducing taxes will increase domestic demand thus encouraging producers to increase production. Furthermore, it would result in higher returns for investors thus encouraging foreign investments. The investment will be in productive sectors of the economy that will generate additional wealth in the US.

References

Gwartney, J., Stroup, R., Sobel, R., & Macpherson, D. (2014). Economics: Private and Public Choice. London: Cengage Learning.
Levey, D., & Brown, S. (2005, March/April). The Overstretch Myth: Can the Indispensable Nation Be a Debtor Nation? Foreign Affairs, 1-7.