macroeconomics essay

twin_deficits_1.ppt

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Current account balance as a percent of GDP, 1960-2012

Sources: Balance on current account: Bureau of Economic Analysis, available on-line at research.stlouisfed.org/fred2/series/BOPBCA. GDP: Bureau of Economic Analysis, available at research.stlouisfed.org/fred2/series/GDP.

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Net international ownership of assets relative to U.S. GDP, 1982-2011

Sources: Net international investment position: Bureau of Economic Analysis, International Investment Position of the United States at Yearend, available online at www.bea.gov/international/xls/intinv11_t2.xls; GDP: Bureau of Economic Analysis, available at research.stlouisfed.org/fred2/series/GDP.

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Twin Deficits Hypothesis

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Fiscal Policy and the Current Account

Are government budget deficits necessarily accompanied by current account deficits?

That is, are there “twin deficits”?

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Twin Deficits

The critical factor: the response of national saving
An increase in the government budget deficit raises the current account deficit only if the increase in the budget deficit reduces desired national saving
In a small open economy, if an increase in the government budget deficit reduces desired national saving, the saving curve shifts left, thus reducing the current account balance

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The government budget deficit and the current account in a small open economy

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Fiscal Policy and the Current Account

The government budget deficit and national saving
A deficit caused by increased government purchases
No question here: The deficit definitely reduces national saving
Result: The current account balance declines
A deficit resulting from a tax cut
Sd falls only if Cd rises
So Sd won’t change if Ricardian equivalence holds, since then a tax cut won’t affect consumption
But if people don’t foresee the future taxes implied by a tax cut today, they will consume more, desired saving will decline, and so will the current account balance

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Fiscal Policy and the Current Account

Application: the twin deficits
Relationship between the U.S. government budget deficit and U.S. current account deficit
Text Fig. 5.12 shows data
The deficits appear to be twins in the 1980s and early 1990s, moving closely together
But at other times (during World Wars I and II, and during 1975) government budget deficits grew, yet the current account balance increased
The evidence is also mixed for foreign countries

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The government budget deficit and the current account in the United States, 1960-2011

Sources: Total government and Federal government receipts, current expenditures, interest, and transfers: BEA Web site, www.bea.gov, NIPA Tables 3.1 and 3.2. GDP: BEA Web site, NIPA Table 1.1.5. Current account balance: BEA Web site, International transactions accounts Table 1.

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Fiscal Policy and the Current Account

Application: the twin deficits
U.S. experience
Early and mid 1980s: supports twin deficits
Federal tax rebate, 1975: contrary to twin deficits
Recent experience: contrary to twin deficits
Experience of other countries
Germany: increased CA deficit and budget deficit
Canada, Italy mid 1980s large budget deficits without severe CA deficits

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Key Diagram 4 National saving and investment in a small open economy

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Key Diagram 5 National saving and investment in large open economies