Question

On Oct 30, 2000 the Wall Street Journal announced that “US income growth slowed to 2.7% from 5.3% in the previous quarter. The 2.7% came in well below the forecasted 3.5%.” Assume Hong Kong and the US are on a fixed exchange rate regime, while the US and Europe are on a flexible exchange rate regime. As income growth in the US decelerates, what do you expect to happen to

1. a) The US trade balance with Hong Kong?

2. b) US reserves?

3. c) The US trade balance with Europe?

4. d) HK output if the reduction in US growth equals a reduction in US autonomous consumption?

Draw a graph to explain each answer.

Answer 1

The US income growth slowed down in the year 2000 because of the weakening of the labour market due to the great recession in US; there was a significant fall in the median income of the country.

a) The US trade balance with Hong Kong

Despite having slowdown in the economy, the US had a trade surplus in every quarter of the year 2000. This was because the US has always been the major exporter of commodities to the Hong Kong and after the great recession, 2000 was the year when the economy of the country started reviving which had trade surplus in every quarter as a result.

b) US reserves

The Reserves comprises of monetary gold, special drawing rights, reserves of IMF members by the IMF and holdings of foreign exchange under the control of monetary authorities. After the Income growth slowdown in the US economy, the reserves would have gone less as the country requires more of funds and the government lend it through the reserves it has.

c) The US trade balance with Europe

The US has always had imports higher than the exports in the case of Europe. In the year 2000, there is trade deficit in every quarter. The deficit has been increasing from the very starting of the great recession and it is still increasing.

d) Hong Kong output if the reduction in US growth equals a reduction in US autonomous consumption

The output of Hong Kong will decrease with the fall in autonomous consumption of US as Hong Kong is dependent on US for various commodities which the US will be using itself for the country's population.