Please make at least 100 words comment on the discussion below. 1. In “Disentang
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Question
Please make at least 100 words comment on the discussion below.
1.
In “Disentangling the Twin Deficits” Robert Blecker provides a number of theories concerning how budget deficits can lead to current account deficits. Specifically, Blecker address the case of the deficit that arose in United States as a result of the Reagan-era tax program. The first explanation describes how the most direct effect of expansionary fiscal policy is an increase in domestic expenditure and increased demand for imports, and how increased demand for imports results in an increased trade deficit when foreign demand for US exports is unchanged. This increased trade deficit matches the reduction in the “national savings” portion of the macro identity. The second explanation describes how expansionary fiscal policy can indirectly affect the trade balance via changes in the value of the dollar. This is speculated to happen because when the US government borrows to finance deficit spending, upward pressure is put on interest rates, and because when US interest rates rise above foreign interest rates, foreign funds flow into US financial assets. The result is increased demand for the dollars needed to buy US financial assets, and the appreciation of the dollar. The higher value of the dollar means that US products (both exported and import-competing goods) are less competitive, and the trade deficit higher. The final explanation pertains to the fact that international capital movements dwarf international trade transactions. Blecker describes how because of this fact, some economists believe that trade (current account) deficits are artifacts of net capital inflows (borrowing from abroad), and how a country should have positive net capital inflows (current account surplus) when rates of return on domestic assets exceed rates of return on comparable foreign assets.
2.
Blecker describes how there are complex interdependencies that link trade and budget deficits to each other, to other macroeconomic variables, and to structural conditions, and that as a result, the explanation for how budget deficits affect trade deficits cannot be simple. His main objection to the channels detailed above as legitimate causes of the current account deficit during the 1980s pertains to the theories’ failure to consider the multiple macro polices that influence the value of the dollar and the trade balance (foreign fiscal policies and both domestic and foreign monetary policies). For example, Blecker explains how the idea of a rising trade deficit as a result of increased net imports is negated if one considers that foreign countries can simultaneously conduct expansionary fiscal policies to stimulate their demand for US exports.
In describing the importance that foreign governments play in determining a home countries budget deficit and trade deficit, the example of the United States, Japan, and Germany during the periods of 1974-1979 and 1980-1987. Blecker explains how during this era, the US government surplus fell while the government surpluses of Japan and West Germany grew, and how fiscal expansion in the US enabled Japan and West Germany to engage in contractionary fiscal policy without suffering from aggregate demand problems as their growing external surpluses substituted for domestic demand. In this sense, opposite movements in fiscal policies led to massive trade imbalances because foreign demand for US goods decreased and US national income and saving was reduced; the US trade deficit was not only the result of increased US budget deficit. Furthermore, Blecker considers a government can finance its increased deficit when government deficit = private savings – domestic investment + net foreign saving, where net foreign saving = current account deficit, how tight monetary policy are raise interest rates and cause the dollar to appreciate, how competitive decline and foreign market barriers have a direct impact on trade flows, and how contractionary foreign macro policies have a negative effect on export growth. In short, Blecker explains that persistent reductions in various measures of the trade balance cannot be attributed to differences in US and foreign macro policies or to changes in exchange rates, and must instead be presumed to reflect structural factors.
3.
As described above, Blecker’s critique of the most common theories on the connections between budget deficits and trade deficits rests in the failure of many economists to consider the decisions of foreign governments and other macroeconomic factors such as monetary policy. For example, Blecker describes how if all countries simultaneously engage in expansionary fiscal policy, the negative effects of an expansion are cancelled out, or alternately how if a foreign country tightens its fiscal policy while a home country expands its fiscal policy, the home country’s trade deficit will increase, foreign demand for exports will decrease, and national saving will be reduced. Blecker also considers the ambiguous effects of an overvalued dollar important on the current account deficit. He describes how an overvalued dollar occurs when tight monetary policy raises interest rates, causing the dollar to appreciate and making American products less competitive, worsening the trade balance, and how higher interest rates depress domestic spending and reduce import demand, improving the trade balance. On a separate note, Blecker considers the assumption that “economic resources are at all time fully employed” as a failure of many economists. Given the inaccuracy of this statement, he thinks that wealth inequality, the US’s lack of a progressive income tax system, and the US’s lack of limits on financial speculation are notable factors that contribute to the nation’s worsening trade deficit.
4.
This issue is very significant to the modern United States’ economy because in recent years the United States has run budget deficits amounting to hundreds of billions of dollars, and because in recent years the United States has run trade deficits amounting to tens of billions of dollars. The issue is also very significant because, economic facts aside, Donald Trump has made eliminating or reducing the trade deficit one of the central points of his presidency, and has pointed to the trade deficit as evidence of the decline of “American greatness.” While a large trade deficit can be a serious issue, I do not believe, for a number of reasons, that the United States’ trade deficit or budget deficit currently possess a serious threat to the United States’ economic stability. However, I agree with Blecker’s assertion that the worsening trade deficit is indicative of larger inequality-related issues in American society. In my opinion, the United States should not take urgent action to reduce the trade or budget deficit, but rather invest in improving public wellbeing and address the domestic fiscal policy-related disparities that affect the trade deficit.
Explanation / Answer
Twin deficit is a situation where a country faces a current account (trade) deficit as well as a budget (fiscal) deficit. Macroeconomic theories describe a strong relation between the budget balance and the current account balance or trade balance. Fiscal deficit is also called government budget deficit. It occurs when a nation’s expense exceeds its revenues. Running a deficit doesn’t seem like a positive development for an economy. However, some would argue that it is necessary to boost a sluggish economy. A nation in recession would find that deficit spending can finance infrastructure projects (which hires workers, boost corporate profits, and builds important networks for commerce). Government can fund these projects by issuing bonds to investors. In effect, the buyers of these bonds are loaning money to the government. When the government repays the debt, investors will get their principal plus an interest on the loan. These bonds are considered safe if it is issued by a stable government because of its ability to print money or raise taxes to generate revenue. Current account deficit occurs when a nation imports more than it exports. Intuitively, many would argue that running a current account deficit is not good for the economy. But there are two sides to the story. Views on a country’s “trade balance” are relative to the economy and business cycle. The logic behind twin deficit is that tax cuts which increase the deficit and reduce revenues result in increased consumption. This spending lowers the national savings rate which increases the amount of money a nation has to borrow from other countries. However, the fiscal deficit and current account deficit are just two parts of the puzzle. There are many other inputs that determine a nation’s fiscal situation.