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Using fiscal policy to address 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.

Financing higher education

Over the period between 1982 and 2012, the increases in the cost of a college education had far outpaced that of the income of the typical American family. According to the research done by the President Obama’s staff, the cost of education at a four-year public college increased by 257% compared to an increase in family incomes of only 16% over the prior 30 years. The ongoing debate over a balanced budget and proposed cutbacks accentuated the need to increase investment in human capital to grow the economy versus deepening the already significant debt levels of the U.S. government. In the summer of 2013, President Obama presented a plan to make college more affordable that included increasing Pell Grant awards and the number of recipients, caps on interest rates for student loans, and providing education tax credits. In addition, the plan includes an accountability method for institutions of higher education that focuses on completion rates and creates a College Scorecard. Whether or not all these initiatives come to fruition remains to be seen, but they are indicative of creative approaches that government can take to meet its obligation from both a public and fiscal policy perspective.

Key concepts and summary

The government need not balance its budget every year. However, a sustained pattern of large budget deficits over time risks causing several negative macroeconomic outcomes: a shift to the right in aggregate demand that causes an inflationary increase in the price level; crowding out private investment in physical capital in a way that slows down economic growth; and creating a dependence on inflows of international portfolio investment which can sometimes turn into outflows of foreign financial investment that can be injurious to a macroeconomy.

Problems

Sketch a diagram of how a budget deficit causes a trade deficit. ( Hint : Begin with what will happen to the exchange rate when foreigners demand more U.S. government debt.)

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Sketch a diagram of how sustained budget deficits cause low economic growth.

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Assume that you are employed by the government of Tanzania in 1964, a new nation recently independent from Britain. The Tanzanian parliament has decided that it will spend 10 million shillings on schools, roads, and healthcare for the year. You estimate that the net taxes for the year are eight million shillings. The difference will be financed by selling 10-year government bonds at 12% interest per year. The interest on outstanding bonds must be added to government expenditure each year. Assume that additional taxes are added to finance this increase in government expenditure so the gap between government spending is always two million. If the school, road, and healthcare budget are unchanged, compute the value of the accumulated debt in 10 years.

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References

The White House. “This is why it's time to make college more affordable.” Last modified August 20, 2013. http://www.whitehouse.gov/share/college-affordability.

Rubin, Robert E., Peter R. Orszag, and Allen Sinai. “Sustained Budget Deficits: Longer-Run U.S. Economic Performance and the Risk of Financial and Fiscal Disarray.” Last modified January 4, 2004. http://www.brookings.edu/~/media/research/files/papers/2004/1/05budgetdeficit%20orszag/20040105.pdf.

Questions & Answers

how to produce
sophia Reply
suppose you are the manager of a perfect competitive firm. your total cost of production is given by TC=100+Q2 suppose you are told that the price of their services is $60 1. how much output should you produce to maximise profit? show calculations 2. determine the level of profit
Niza Reply
220
ezhilarasan
how to produce
sophia
what is price control
Raphael Reply
importance of scale of preference
Offei Reply
what are the factors that affect international organization
Imeobong Reply
Organizational structure,communication,mission
Ogunsola
what is international organization
Imeobong Reply
discuss how international organization affect business in Nigeria
Imeobong
An international organization is an organization with an international membership, scope, or presence.
Avishek
thanks
Imeobong
importance of scale of preference
Offei
demand curve
Raphael
demand uuu
Raphael
uu
Raphael
supply curve
Raphael
what is price control
Raphael
what are the factors that affect demand and commodity
Beatrice Reply
if a firm stays on the same isoquant it means ? a. output missteps decrease b. output must stay. the same c. output must increase d. quantity of labour and capital employed must remain the same e. none
Niza Reply
A
Were
A
alyssa
B
SEMAN
A
Darren
B
Bertilla
D
Romeo
which one is the right answer pls
Bertilla
😂😂😂😂
Niza
it's bad
Niza
B
Foley
d
Fasae
b
Alicia
a
Mohammed
hi
DINA
d
DINA
d) none. because isoquants meant different combination of inputs give same level of out and higher the isoquants gives higher the level of output
ezhilarasan
okay
Bertilla
answ. d.quantity of labour and capital employed must remain equal
mohamed
d
Ayoka
B
jephter
analyse this table showing how this affect the law of diminishing demand return
michael Reply
What are diminishing marginal returns as they relate to costs?
michael
what are diminishing demand
Bertilla
please can you explain it to me because am new to economics
michael
the law of diminishing state that as more and more variable factor is added to a fixed cost, it will increase first and later its begins to fall until its get to zero. that were ur mc equal to zero
Fasae
thanks dr
Bertilla
The law of diminishing demand states that, if the price of a product is raised, a smaller quantity will be demanded and if the price of a product is lowered, a greater quantity will be demanded.
Were
The law of diminishing returns, also referred to as the law of diminishing marginal returns, states that in a production process, as one input variable is increased, there will be a point at which the marginal per unit output will start to decrease, ceteris puribus
Were
guys I need to know what is meant by basic economic mathematics and explain please
Lovemore Reply
It's also the usage of mathematical tools to express and analyse economic problems.
Rasaq
so basically it's the use of mathematical formulas to solve the problems under demand and supply right...
Lovemore
Yes, though economic analysis majorly has to deal with demand and supply forces in fact the back bone of economics rest on demand and supply but there are other functions like consumption function, implicit ,explicit, monotonic( constant, increasing, decreasing), transcendential, homogeneous, polyn
Rasaq
wat improvement do economic has with our life
Aminata Reply
it help us how to use our limited resources to satisfy our unlimited wants
Pagnol
Economics assit in understanding the pre-requisite for Growth and developmen and how the workings of the economy operates.
Rasaq
Economic helps us to manager our limited resources, how to expand it, etc over unlimited want
Eagle
Economics is the social Science in which we study how scarce resources are allocated for the betterment of human being.
Ali Reply
what is equilibrium point
Happiness Reply
where price and quantity demanded meet
Pagnol
is the point where price an quantity demanded meet
Aminata
why do consumer demand curve tend to move downward slope
Aminata
Equilibrium point is the point at which quantity demand equals quantity supply.
Rasaq
What is monopoly
Ezekiel Reply
Is a strict example of an imperfect market where there is only one seller and many buyer for a particular product.
Rasaq
what is economics
BUKENYA Reply
economics us behavior. Of people, nations, markets etc. It has much to do with reactions. watch MSNBC. Bloomberg. everyday they talk about how the markets react to an piece of news, legislation, interest rates etc. Interesting volatile stuff
TOM
but, it also react with science
ezhilarasan
economic is a science with study's the behavior of people,market and price
Bertilla
it's a science which study the behavior of people ,market n price
Bertilla
What is opportunity cost?
Junior
opp. cost~a benefit, profit or value of something that must be given up to acquire or achieve something else
Kim
or something that you foregone
Kim

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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