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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

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
ru
anything which is widely acceptable as a medium of exchange
Shabana Reply
money ,currency
ru
Hello plz,what is the full mean of tertiary?
al Reply
tertiary also called philoshper
Waseem
tertiary means third..for example primary sector ,secondary and tertiary sector... means three number..
ru
ru 9ice tnk
al
your most welcome.
ru
tnz
al
what is money
Tettey
what is a bank
Walters
a financial institution which holds money for its clients ,which collect deposit and lend money at interest and trades generally in money...
Shabana
what is bankers draft ?kindly explain with example .
Shabana
money "anything which is widely acceptable as a medium of exchange"
Shabana
yes u ryt #shabana
Dar
difference between cost and price
Dar
Shallow definition
Adam
cost"the value of input that is the amount of money which is used to produce a good or service . price"an amount of money which has to b paid to buy something.
Shabana
Tertiary is an adjective(pre position) for stages or levels and refers to "top, final, full term ." ; Advanced.
Anderson
bank draft is a type of cheque which a person buy for to pay someone who is not willing to accept a personal cheque .
ru
what is occupational structure
Madhu Reply
occupational structure refers to the distribution of occupation on the basis of educational ,socoial ,income level in a society or economy
ru
no that is not a exact meaning
Madhu
than what is exact meaning
Dharam
what is deficit
Obiajunwa Reply
deficit = expenses > revenue
Waseem
yeah expenses over revenue results in deficit
Paulina
insufficiency
Anderson
What is What is Equilibrium
Bright Reply
from business point of view it is that point where business revanu are equal to its expenses.
ru
in economy where demand is equal to supply is called equalibrium
ru
Equilibrium in economics is where quantity demanded is equal to quantity supplied
Collins
what are the objectives of devaluation
Oyedun
how the government solve the problem of scarcity
SUNDAY Reply
how government solve the problem of scarcity
SUNDAY
by deciding the output limit for every industry and providing resources to these industries according to output limit .the problem can be solved
ru
and by controlling the activity of production like as a mixed economy this problem can be solved
ru
by proper planning to cater the needs of people, demand & supply process may prove helpful. and by imposing heavy import duty on the product to shift the demand towards available alternative sources.
Abida
changing the methods of production, and tax system
Khushal
In problems of scarcity government should adopt a plan or state budget, form a long term policy , deal with corruption , mobilise resources ,systems and monitor.
Anderson
by doing various plans or scheme and providing various kind of free or in less price to the needy people
Madhu
Plx anyone explain bankers draft by giving example.
Shabana
what is price elasticity of demand?
Asamoah Reply
price elasticity of demand is the percentage in quantity demanded of a good or service to the percentage change in its price.
Cobbina
Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price when nothing but the price changes.
TOHEEB
Price elasticity of Demand is a prepotionat change in the demand due to change in price of the goods and service
Dawal
what is monopoly and monopolistic?
KPAAKPA
Price elasticity of demand is the economy measure to show the responsiveness and change in price due to change in quantity.
Lomayani
what is economics
Kenethy Reply
one simple reason to build format in level great leverage for better control knowing grown level greater with word trade..
Larod
Any one who can assit me with Multiplier
Wendy
Yeah sure
Aqrar
You mean Multiplier effect!5
Aqrar
ECONOMICS IS THE STUDY OF ECONOMIC ISSUES OR (ECONOMIC PROBLEMS)ARUSING OUT OF THE FACT THAT RESOURCES ARE SCARCE IN RELATION TO OUR NEEDS,DESIRES OR WE CAN SAY THAT RESOURCES ARE LIMITED OR WANTS ARE UN LIMITED HOW CAN WE UTILIZE LIMITED RESOURCES FOR SETESFY OUR WANTS
Nazneen
is called economics
Nazneen
is call economist
KPAAKPA
then
Nazneen
Economics is all about management of scarce resources. In other words its is about efficience.
Aqrar
Nazneen lets discuss some advance concepts and models
Aqrar
I.can see you have good concepts of Econ
Aqrar
what is multiplier
Wendy
@Wendy A phenomenon whereby a given change in a particular input, such as government spending, causes a larger change in an output, such as gross domestic product.
Aqrar
economic is social science that deal with the human behavior as a difference b/ween earth and scale.
jacob
Economics is a science that studies human behaviour in relation to ends and scarce means which have alternative uses
Collins
economics is a social science that deal with human behavior in aspect of end and scarce and the alternative use
Chibuzor
pls I want to known the difference between inflation and deflation, what is there difference ?
jacob
economics is the study of how man used scarce recourse to satisfy human wants
abdullahi
inflation is the increase in the general price level while deflation is decrease in general price level.
Azhar
evening,dear friends. I'm very glad to be one of you so will you please give me full imformaton about economics epically the time table of the first year of the univerysity
abdullahi
hi iam from india
Naa
economic is the study of human behavior, want by professor Robert say is all about choice and want
KPAAKPA
what is SCARCITY?
KPAAKPA
Scarcity is the limitation of resources within the economy
karl
means that human wants for goods, services and resources exceed what is available
KPAAKPA
Scarcity is inefficient resources to satisfy human want.
Pat
inflation can define as general rise in the price due to too much money in circulation, while is the decrease of the price of goods due to low money in circulation.
Musa
what is the law of dimension return?
jacob
Jacob it's diminishing return
The
The study of house hold management and money measurements
Wardan
hi
Augustine
what is mearnt of economies of scale..pls asist me
Augustine
hii
Vimarsh
when larger amount of output is produced , per unit input costs tend to fall , heading towards economiea of scale ..by acale we mean scale of production here
Vimarsh
economies# scale#
Vimarsh
alright thank u..what are its advantages
Augustine
the cost of production is low and more efficient
Vimarsh
What is demand?
Bright
demand is the various goods and services consumers are willing and able to purchase at a particular price
Paulina
What is inflation
Bright
Economics is a social science focusing on the economy and its agents in production,distribution,buying and selling involving resources such as raw materials and labour at micro ie individual or family and macro ie aggregate or total and state levels . There are several forms or brands or approache
Anderson
scarcity means non availability things or resources which satisfy humans
Madhu
demanding the various goods and services which satisfy humans needs
Madhu
when we calculate shortage and surplus why do we subtract quantity demanded from quantity supplied
The Reply
to determine surplus
Concepcion
true using of graphs
jacob
because we try to avoid negative answers
Eric
what is price ceiling
Nazneen Reply
price ceiling is a government-imposed price control, or limit, on how high a price is charged for a product. Governments use price ceilings to protect consumers from conditions that could make commodities prohibitively expensive.
Rina
price effect= Income Effect+ Substitution Effect
Muhammad
Well described Rina
Aqrar
why average revenue is equal to price in monopoly market?
khin Reply
Because One person get the monopole on demand market without any concurrence
Christian
hlw
Luman
hlw
Sheikh
Black money comes from black mark
james Reply
why perfect competition is also known as price taker?
Chening Reply
In perfect competition a firm is a price taker rather to be a price maker because the products it produces are homogeneous so no one will pay extra. price taker means that firms can not set the price it want. If it charged high price then market price its goods will remain unsold.
Azhar
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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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