Suppose initially Canada has all its international payments accounts in balance no surplus or deficit).Then Canadian firms increase the amount they export to Japan, and the Japanese finance the increase by borrowing from Canada.In Canada, everything else remaining the same, there will now be a
A)capital and financial account surplus and a current account deficit.
B)capital and financial account deficit and a current account surplus.
C)capital and financial account deficit and a current account balance.
D)capital and financial account deficit and a current account deficit.
E)capital and financial account surplus and a current account surplus.

Question

Quizplus · Accepted Answer

When Canadian firms increase their exports to Japan, it means Canada is selling more goods to Japan than it is buying from it, leading to a current account surplus. The financing of this increase in exports by Japanese borrowing from Canada results in an inflow of capital from Japan to Canada, which is recorded as a capital and financial account deficit because Canada is lending (exporting capital) to Japan, not borrowing (importing capital) from it. However, the correct interpretation in the context of balance of payments should be a capital and financial account surplus (not deficit as previously mentioned), as the lending to Japan represents an increase in Canadian assets abroad. Therefore, the correct explanation should reflect that an increase in exports leads to a current account surplus, and the financing of these exports by Japanese borrowing should lead to a capital and financial account surplus, not deficit. This correction addresses the misunderstanding in the explanation provided.

Suppose Initially Canada Has All Its International Payments Accounts in Balance