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Short-term movements in the business cycle and the trade balance

In the short run, trade imbalances can be affected by whether an economy is in a recession or on the upswing. A recession tends to make a trade deficit smaller, or a trade surplus larger, while a period of strong economic growth tends to make a trade deficit larger, or a trade surplus smaller.

As an example, note in [link] that the U.S. trade deficit declined by almost half from 2006 to 2009. One primary reason for this change is that during the recession, as the U.S. economy slowed down, it purchased fewer of all goods, including fewer imports from abroad. However, buying power abroad fell less, and so U.S. exports did not fall by as much.

Conversely, in the mid-2000s, when the U.S. trade deficit became very large, a contributing short-term reason is that the U.S. economy was growing. As a result, there was lots of aggressive buying in the U.S. economy, including the buying of imports. Thus, a rapidly growing domestic economy is often accompanied by a trade deficit (or a much lower trade surplus), while a slowing or recessionary domestic economy is accompanied by a trade surplus (or a much lower trade deficit).

When the trade deficit rises, it necessarily means a greater net inflow of foreign financial capital . The national saving and investment identity teaches that the rest of the economy can absorb this inflow of foreign financial capital in several different ways. For example, the additional inflow of financial capital from abroad could be offset by reduced private savings, leaving domestic investment and public saving unchanged. Alternatively, the inflow of foreign financial capital could result in higher domestic investment, leaving private and public saving unchanged. Yet another possibility is that the inflow of foreign financial capital could be absorbed by greater government borrowing, leaving domestic saving and investment unchanged. The national saving and investment identity does not specify which of these scenarios, alone or in combination, will occur—only that one of them must occur.

Key concepts and summary

The national saving and investment identity is based on the relationship that the total quantity of financial capital supplied from all sources must equal the total quantity of financial capital demanded from all sources. If S is private saving, T is taxes, G is government spending, M is imports, X is exports, and I is investment, then for an economy with a current account deficit and a budget deficit:

Supply of financial capital  =  Demand for financial capital S +  (M – X) = I +  (G – T)  
A recession tends to increase the trade balance (meaning a higher trade surplus or lower trade deficit), while economic boom will tend to decrease the trade balance (meaning a lower trade surplus or a larger trade deficit).


Imagine that the U.S. economy finds itself in the following situation: a government budget deficit of $100 billion, total domestic savings of $1,500 billion, and total domestic physical capital investment of $1,600 billion. According to the national saving and investment identity, what will be the current account balance? What will be the current account balance if investment rises by $50 billion, while the budget deficit and national savings remain the same?

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[link] provides some hypothetical data on macroeconomic accounts for three countries represented by A, B, and C and measured in billions of currency units. In [link] , private household saving is SH, tax revenue is T, government spending is G, and investment spending is I.

Macroeconomic accounts
SH 700 500 600
T 00 500 500
G 600 350 650
I 800 400 450
  1. Calculate the trade balance and the net inflow of foreign saving for each country.
  2. State whether each one has a trade surplus or deficit (or balanced trade).
  3. State whether each is a net lender or borrower internationally and explain.

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Imagine that the economy of Germany finds itself in the following situation: the government budget has a surplus of 1% of Germany’s GDP; private savings is 20% of GDP; and physical investment is 18% of GDP.

  1. Based on the national saving and investment identity, what is the current account balance?
  2. If the government budget surplus falls to zero, how will this affect the current account balance?

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Questions & Answers

What is scarcity?
Jubille Reply
having unlimited needs and wants in a world of limited resources
what are the indicator of over population
Accorobatic Reply
Inefficiency of natural resources
Low PCI .
what product market?
Gayflor Reply
explain demand
Bless Reply
what is economics
Economics is the social science that studies the production, distribution and consumption of goods and services.Economics focuses on the behaviour and interactions of economic agents and how economies work.
Pls what is national income?
demand is the number of buyers. as the price of goods is increase, the buyers will not consider to buy the goods, so the demand will decreases
National Income is the aggregate monetary value of all final goods and services produced in an economy in an year .
Why pecularities of land has no economic significance, What the economic bad, effictive demand?
what is deadweightloss
francis Reply
deadweight loss is the allocative inefficiency.... when the equilibrium for good or services is not achived.
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What are the implications of classical Economics?
What are the implications of classical Economics school of thought?
Dead weight loss is an inefficient allocation of resources, especially through taxation or restrictions.
Classical Economics had an influenced by ancient economic principle and theory.
hello please what is localization of industry
Bless Reply
price is tantalisingly the only factor determining demand which can be analyze the view
Sinit Reply
Price is tantalizingly the only factor determining demand which can be analyze the view
what is scarcity
Sharkdanny Reply
the state of being scarce or in short supply; shortage.
what is meant by an abnormal demand curve?
Samuel Reply
what is microeconomics
Berun Reply
micronomics can be define as that part of Economics that deals with small scale business. e.g. House hold stuff
Micro economics is the study of individuals, households and firms' behavior un decision making and allocation of resources
what is underemployment
Xornam Reply
It is the situation where the available resources are not used to it optimum
state the law of diminishing returns
Bless, the law of diminishing returns state that one point, adding a single worker will result in a decrease of production.
it is a situation where by people are employ but work under their potential
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Akua pls when you say people alone? what about facilities?
Definition of underemployment. 1 : the condition in which people in a labor force are employed at less than full-time or regular jobs or at jobs inadequate with respect to their training or economic needs
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what does law of demand says?
with a diagram explain fairy elastic demand
comprehensive answer for public finance is the money that a government has available to spend from taxes and borrowing.
wilflay Reply
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Definition of demand and supply
oyebanji Reply
whatd is name of economic scholars defined classic view
Ahmed Reply
Whole Classical view is based on J.B.Say's Law of Marker demand

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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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