Macroeconomics fiscal deficit and trade balance

Macroeconomics fiscal deficit and trade balance

While some might object to focusing on a given fiscal policy because a budget deficit could result from changes in other components of the identity, it is this deficit, and this deficit alone, that is largely under the control of policymakers.

Hence, a budget deficit can also lead to a trade deficit, causing a twin deficit. Protectionist policies aimed at this objective will surely miss the mark.

how trade deficit works

Promise of the Plaza As we have seen, the stance of fiscal policy is at the heart of our trade imbalance and the associated sectoral problems. If, for example, improvement comes through import restrictions, it will simply result in growing weakness in private investment.

Not unexpectedly, low-tech is an area where the United States has run a trade deficit for years. If the U. Then the U.

Budget deficit and trade deficit relationship

Demand for U. What remains important to acknowledge is that the relationship between debt and growth is negative and that for some countries, the relationship may be stronger than in others. In the process, high real interest rates would crowd out private financing. There are any number of scenarios that might play out, but prices, interest rates and exchange rates in particular, are likely to be central to all of them. In developing countries, it is often hard to raise the funding needed to make investments in infrastructure or manufacturing because local savings levels are too low, and foreigners have a very limited appetite for bringing money into the country and will only do so at very high rates. The risk of high inflation or a default on repaying international loans will worry international investors, since both factors imply that the rate of return on their investments in that country may end up lower than expected. Further, assuming that the economy is operating at full employment so that real income and savings are fixed and assuming savings are not responsive to changes in interest rates , a budget deficit increase will result in higher real interest rates and depress private investment. Of course, no one should expect the budget deficit and trade deficit to move in lockstep, because the other parts of the national saving and investment identity—investment and private savings—will often change as well. The impact of chronically large budget deficits is as follows: As the population ages, there will be an increasing demand for government services that may cause higher government deficits. But beyond some point that is hard to define in advance, a series of large budget deficits can become a cause for concern among international investors. Just as a few falling rocks can trigger an avalanche; a relatively small piece of bad news about an economy can trigger an enormous outflow of short-term financial capital.

Misgivings Despite this apparent success, there should be serious misgivings about the way in which the Plaza Agreement has been implemented. Depending on the explanation selected, alternative remedies have been proposed. Thus, a budget deficit can easily result in an inflow of foreign financial capital, a stronger exchange rate, and a trade deficit.

how to reduce trade deficit

The identity also implies that given fiscal policy, a narrowing of the savings surplus e. The interest on outstanding bonds must be added to government expenditure each year. References The White House. It is at least as likely, however, that cutting the fiscal deficit will simply increase debt or increase unemployment.

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Fiscal Policy and the Trade Balance