You observe that during the past few years that New Zealand's current account deficit has become smaller. This could be due to
1. the New Zealand government's buy New Zealand campaign which has reduced imports in favor of domestically produced goods.
2. an increase in lamb exports as a result of a shift of resources from beef to lamb production.
3. policies of the New Zealand government that have created uncertainty about the future returns from investing in New Zealand.
4. any or all of the above.
Choose the correct option.
Option 3 is the correct one. The equilibrium current account deficit can only get smaller if savings increases relative to investment. Nothing in options 1 or 2 suggest any reason for savings to have increased or investment to have declined in New Zealand. Hence, they must be rejected as reasons for observing a decline the current account deficit. In the absence of a change in savings or investment, shocks to imports and exports will be offset by movements of the real exchange rate. A decline in investment in New Zealand, on the other hand, will make the excess of savings over investment larger and the net capital inflow smaller.
This question exposes a classic fallacy that frequently appears in the popular press. People think that a positive shock to exports or a negative shock to imports must increase the current account surplus (or, in the case above, reduce the current account deficit). This seems obvious because, after all, the current account balance equals exports minus imports. But an understanding of economics tells us that shocks are merely the forces that drive the economic system---the ultimate results depend on the effects of these shocks on the equilibrium of the system. In this case, the equilibrium current account balance is the same as it was before and the equilibrium real exchange rate is higher.