Fiscal Policy Affects Trade Imbalances
How Fiscal Policy Can Affect Trade Imbalances?
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How can Fiscal Policy Affect Trade Imbalances?
If a nation is experiencing the inflow of foreign investment capital associated with a trade deficit because foreign investors are making long term direct investments in firms, there may be no substantial reason for concern. After all, many low-income nations around the world would welcome direct investment by multinational firms that ties them more closely into the global networks of production and distribution of goods and services. In this case, the inflows of foreign investment capital and the trade deficit are attracted by the opportunities for a good rate of return on private sector investment in an economy.
However, governments should beware of a sustained pattern of high budget deficits and high trade deficits. The danger arises in particular when the inflow of foreign investment capital is not funding long-term physical capital investment by firms, but instead is short-term portfolio investment in government bonds. When inflows of foreign financial investment reach high levels, foreign financial investors will be on the alert for any reason to fear that the country’s exchange rate may decline or the government may be unable to repay what it has borrowed on time. 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.
Reducing a nation’s budget deficit will not always be a successful method of reducing its trade deficit, because other elements of the national saving and investment identity, like private saving or investment, may change instead. In those cases when the budget deficit is the main cause of the trade deficit, governments should take steps to reduce their budget deficits, lest they make their economy vulnerable to a rapid outflow of international financial capital that could bring a deep recession.
Back to: ECONOMIC ANALYSIS & MONETARY POLICY
- What is Government Spending?
- Autonomous Spending
- Autonomous Consumption
- Fiscal Policy
- Expansionary Fiscal Policy
- Progressive vs Regressive Tax
- Marginal Tax Rates
- Proportional Tax
- Trickle Down Theory
- Effects of Discretionary Policy (Interest Rates & Lags)
- Crowding Out Effect
- Government Borrowing
- Golden Rule
- Ricardian Equivalence
- Balanced Budget - Deficit and Surplus
- Deficit Hawk
- Fiscal Policy and the Aggregate Supply and Demand Curve
- Stabilization Policy
- Robin Hood Effect
- Ricardo Barro Effect
- Automatic Stabilizers
- Standardized Employment Budget
- How Does Fiscal Policy Affect Interest Rates?
- Crowding Out
- Types of Lag in Fiscal Policy
- Temporary and Permanent Fiscal Policy
- Limitations of Fiscal Policy?
- How Politics Affects Discretionary Fiscal Policy
- Government Borrowing
- Debtor Nation
- Fiscal Policy Affects Trade Balances
- Twin Deficits
- Exchange Rates Affect Budget and Trade Deficits
- What are the risks of chronic large deficits in the United States?
- How Fiscal Policy Can Affect Trade Imbalances
- Government Borrowing Affect Private Savings
- Ricardian Equivalence
- Fiscal Policy Affects Investment and Economic Growth
- Crowding Out of Physical Capital Investment?
- How Does Government Borrowing Affect Interest Rates in Financial Markets?
- Government Investment in Physical Capital
- Public Investment in Human Capital
- Fiscal Policy Can Affect Technology Development
- Skyscrapper Effect (Economics)
- V-Shaped Recovery
- W-Shaped Recovery
- U-Shaped Recovery
- Kondratieff Wave Cycle
- Feedback Rule Policy
- American Customer Satisfaction Index
- CNN Effect
- Bureau of Economic Analysis
- Business Starts Index
- American Recover and Reinvestment Act
- Emergency Economic Stabilization Act of 2008
- Commodity Credit Corporation
- Humphrey Hawkins Act