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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.


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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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

can anyone suggest how to put questions here?
Gopal Reply
Go on any topic for example perface
Then go at last and write in new conversation
why demand and supply equal
Ashitosh Reply
Demand equal to supply coz if supply more then price less and if price less then demand more also opposite​
M i right ?
if supply will be more then the demand, then price will fall down. same with the demand. if the demand is high, then price of the product will rise.. and equilibrium happens when both supply and demand are at equal level.
what is the scope of being an economist?
sheraz Reply
what is the scope of economics?
Economies of scope is a term that refers to the reduction of per-unit costs through the production of a wider variety of goods or services.
but Cette I meant something else...
I mean where can an economist find a job? I mean in which fields?
Does trade war effect world economy growth?
Yes,it does
yh it will
what is the difference between explicit cost and implicit cost
ustaz Reply
explicit cost:it is the cost which company made for purchasing or hiring resources from the factor owner. implicit cost : the cost of the owner of the company pay for the project.
explicit cost is that cost which is identified by the books of accounts of an organisation
implicit cost is that cost which is not shown in the books of accounts but due to this cost organisation gets some benefits
what is supply
The willing and able to sells their goods in various price of a commodity is called supply.
what are the laws of supply
what is lonrenzo curve
What is price elasticity of demand?
Kanishka Reply
price elasticity of demand is a measure used in economics to show elasticity of quantity demanded of good or service to get a change in it's price while nothing but price changes.
Price elasticity of demand is a measure of the change in the quantity demanded of a product in relation to its price change Price elasticity of demand = % change in quantity demand / % change in Price
Pls where can I found PRICE CONTROL on this app
Samuel Reply
top left corner
A situation in an economy with one producer but many consumers
Kabali Reply
What is the theory of population according to Malthus?
What is the Malthusian population theory?
The Malthusian theory of population state that, where there are means of substinence like food, human beings have the tendency to procreate (ie.give birth) without restraint (ie. control).
he stated that population unchecked grows at a geometric progression ie 1,2,4,8,16 while the means food subsistence grows at arithmetic progression ie 1,2,3,4,5---- he declared that population has the tendency to outstrip the means of subsistence
What is money?
money is any commodity that act as a medium of exchange
money is medium of exchange which is use in taking goods and giving some of it's worth or money value
what is a debit card and a credit card?
a debit card is a payment card used instead of cash while purchasing
a credit card is a payment card issued to users to enable cardholder to pay a merchant for goods and services
oky tanx
What is an inferior good.?
In economics, an inferior good is a good whose demand decreases when consumer income rises (or demand rises when consumer income decreases), 
what is monopoly
Richmond Reply
a market situation when there is only one seller of a product representing whole industry.
where one business is the dominant one in that market. It determines the market price as they are price makers. No entry, no competition.
it is a market situation where is a single seller and many buyer hear the seller is the price maker the is no free entering and exit in this market
A situation in the economy where there is one producer and many consumers
A market situation where there is one producer and many consumers.
Balance of payments for 2018
Mahlatse Reply
what is monopoly and what is monopolaist
Javid Reply
what is the affect of rise in value of dollar ?
monopoly"a single firm or company owns all or nearly all of the market for a given type of product or service "monopoly is a price maker ...barrier of entry ,non availability of close substitute.
monopolistic competition or market is a situation where there are few or many firm producing identical but differentiated product .eg difference in advertisement ,packing etc
monopolistic competition or market is a situation where there are few or many firm producing identical but differentiated product .eg difference in advertisement ,packing
monopoly is a market situation ...where there is a single seller and large number of buyers deals with commodities having no close substitutes......here the sellers are price makers... there is restrictions in the entry and exit of new firms in this market structure....
what is money?
money is a medium of exchange.....through which...commodities are bought and sold
money is a medium/means of exchange that generally accepted by law
What is tranfer earnings
what is savings income?
transfer earning is the minimum income that a factor is willing to accept in an occupation,it is also call the supply price of a factor
what is envelope curve
what is depreciation
depreciation means decrease in value of a assets due to normal wear or year ,means decrease in value of assets like a machine due to its daily use
Refers to wear and tear of capital machinery
what is meant by currency depreciation?
an envelope curve is also call an umbrella curve it is any curve that is enclosed by being tangen t to a series of other curves
fall in the value of currency vis-a-vis any other currency usually $ due to marker forces is called currency depreciation. it is different from devaluation where in value of currency is deliberately reduced to improve BoT
depreciation in its broad sense means loss in the value of fixed capital say a tractor due to i) normal wear and tear ii) normal rate of accidental damage iii) expected absolescence to meet this, Depereciation Reserve Fund is created it is calculated by firms on the basis of their experience.
what is green revolution ?discuss the achievement of green revolution in India
Sweety Reply
green revolution is the third revolution of agricultural refers to a set of research and development of technology transfer initiative occuring between 1930s and the late 1960s that increased agricultural is called green revolution
the green revolution happened because to improve the agricultural sector towards adopting mordern methods and improvement of agricultural equipments
green revolution means new innovation for high yielding varieties seeds towards economic development in agriculture sector. started in 1966, it's achievement increase per productive of all crops ie rice, wheat,maiz,etc...mainly 131 million food grain in 1978-79 produced in india
Punjab and haryana was the first 2 states which have been successfully adopted hyv's and due to this adoption these two states find more successfull in india and it contributed though our national income and also to GDP growth this helps in development of our nation.
what calculation for demand and supply
Amoo Reply
what is nationalisation
Awuni Reply
it is a process of converting private assets into public assets by undertaking the control of government or state authority
so true
what are some the things that may lead to nationalisation
Over exploring of customers by the private individuals Also to make the nationalised organisation social reliable and accessible by all
feeling of one's is called nationalisation. unity among them self .
anything which is widely acceptable as a medium of exchange
Shabana Reply
money ,currency

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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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