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Effects of change in budget surplus or deficit on investment, savings, and the trade balance

Following from the national savings and investment identity, charts (a) and (b) show what happens to investment, private savings, and the trade deficit when the budget deficit rises (or the budget surplus falls). (a) If the budget deficit rises (or the government budget surplus falls), the results could be (1) domestic private investment falls or (2) private savings rise or (3) the trade deficit increases (or a trade surplus diminishes). The opposite results of each are achieved when the budget deficit falls (or the budget surplus rises) as shown in image (b).
Chart (a) shows the potential results when the budget deficit rises (or budget surplus falls). Chart (b) shows the potential results when the budget deficit falls (or budget surplus rises).

What about budget surpluses and trade surpluses?

The national saving and investment identity must always hold true because, by definition, the quantity supplied and quantity demanded in the financial capital market must always be equal. However, the formula will look somewhat different if the government budget is in deficit rather than surplus or if the balance of trade is in surplus    rather than deficit . For example, in 1999 and 2000, the U.S. government had budget surpluses, although the economy was still experiencing trade deficits. When the government was running budget surpluses, it was acting as a saver rather than a borrower, and supplying rather than demanding financial capital. As a result, the national saving and investment identity during this time would be more properly written:

Quantity supplied of financial capital = Quantity demanded of financial capital Private savings + Trade deficit + Government surplus = Private investment S + (M – X) + (T – G) = I

Let's call this equation 3. Notice that this expression is mathematically the same as equation 2 except the savings and investment sides of the identity have simply flipped sides.

During the 1960s, the U.S. government was often running a budget deficit, but the economy was typically running trade surpluses. Since a trade surplus means that an economy is experiencing a net outflow of financial capital, the national saving and investment identity would be written:

Quantity supplied of financial capital = Quantity demanded of financial capital Private savings = Private investment + Outflow of foreign savings + Government budget deficit S = I + (X – M) + (G – T)

Instead of the balance of trade representing part of the supply of financial capital, which occurs with a trade deficit, a trade surplus represents an outflow of financial capital leaving the domestic economy and being invested elsewhere in the world.

Quantity supplied of financial capital = Quantity demanded of financial capital demand Private savings = Private investment + Government budget deficit + Trade surplus S = I + (G – T) + (X – M) 

The point to this parade of equations is that the national saving and investment identity is assumed to always hold. So when you write these relationships, it is important to engage your brain and think about what is on the supply side and what is on the demand side of the financial capital market before you put pencil to paper.

As can be seen in [link] , the Office of Management and Budget shows that the United States has consistently run budget deficits since 1977, with the exception of 1999 and 2000. What is alarming is the dramatic increase in budget deficits that has occurred since 2008, which in part reflects declining tax revenues and increased safety net expenditures due to the Great Recession. (Recall that T is net taxes. When the government must transfer funds back to individuals for safety net expenditures like Social Security and unemployment benefits, budget deficits rise.) These deficits have implications for the future health of the U.S. economy.

United states on-budget, surplus, and deficit, 1977–2014 ($ millions)

The graph shows U.S. government budgets and surpluses from 1977 to 2014. The United States has only had two years without a government budget deficit. In the 1980s the deficit hovered above –$200 million, gradually becoming a surplus by the end of 1990s. From 2000 onward, the deficit grew rapidly to –$600 million. The deficit was at its worst in 2009, at close to $1.6 trillion, following the Great Recession. In 2014, it was around –$514 million.
The United States has run a budget deficit for over 30 years, with the exception of 1999 and 2000. Military expenditures, entitlement programs, and the decrease in tax revenue coupled with increased safety net support during the Great Recession are major contributors to the dramatic increases in the deficit after 2008. (Source: Table 1.1, "Summary of Receipts, Outlays, and Surpluses or Deficits," https://www.whitehouse.gov/omb/budget/Historicals)

A rising budget deficit may result in a fall in domestic investment, a rise in private savings, or a rise in the trade deficit. The following modules discuss each of these possible effects in more detail.

Key concepts and summary

A change in any part of the national saving and investment identity suggests that if the government budget deficit changes, then either private savings, private investment in physical capital, or the trade balance—or some combination of the three—must change as well.

Questions & Answers

Leo Robinson's definition
Adejimi Reply
how is equilibrium defined in financial markets?
Babakura Reply
the concept of it
DALOM
Country A has export sales 20 billion, government purchases 1000billion, business investment is 50 billion, imports are 40billion, and consumption spending is 2000billin. What is the dollar value of GDP ?
Habtamu Reply
what is determination of national income?
Waqar Reply
economic growth
Rukaiya
stock of capital
Rukaiya
we're RBI keep money with them
Anil
Y =C+l
Favour
evaluate the success affirmative action as one of south Africa's redress method
Tebatso Reply
what is market equilibrium
explorer Reply
it is a situation in which the supply of an item is exactly equal to it dd .
Ssmith
inder wat condition shld a firm stop production in both short n lungrun ?
Ssmith
what is 2nd degree price discrimination?
Ssmith
what is quantity
Tettey
what is quantity2
Deji Reply
An indefinite amount of something.
explorer
what is demand
Kaman Reply
in ordinary sense demand means desire
Khalid
demand in economics means both willingness as well as the ability to purchase a commodity by paying a price an also its actuall purchase
Khalid
what is absolute advantage
Khalid
demand refers to the various quantity of goods and services that consumers are willing and able to purchase at a particular period of time all other things been equal
Dela
The amount of a good or service that consumers are willing to buy at a particular price.
explorer
what is cost pull inflation?
oru
what is utility
oru
what is cost pull inflation?
oru
demand is economic principle referring to a consumer's desire and willingness to pay a price for a specific or service..
Babakura
utility is the among of certisfaction driving from using a comundity
Anas
pull cost of inflation hight population unemployment to some of The country members poor government system
Anas
what is a buffer scheme
Lukong
state the second law of demand and supply
Ahmadou Reply
state the law of diminishing marginal utility
Ahmadou
dt know WATS the answer
Rukundo
mention and explain two Bank I financial institutions and two non baking financial institutions
Onah Reply
wat is demand pull inflation
Tony Reply
Demand-pull inflation is asserted to arise when aggregate demandin an economy outpaces aggregate supply. It involvesinflation rising as real gross domestic product rises and unemployment falls, as the economy moves along the Phillips curve.
kevin
Perfectly elastic demand
Abubakar Reply
this is a form of demand where goods are demanded at a constant price
Rukundo
what inelastic demanding
Koire
demand of any good demanded more after a certain period. if a commodity prices may high and scarcity of that resources.
Anil
cannot demand more
Anil
what is cross-elasticity of demand
Miles Reply
cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demand of one good when a change in price takes place in other good
Mallekha
this is responsiveness quantity demanded keeping other factors constant
Rukundo
what economic growth
Rukundo Reply
conditions of perfect market
NdzAlama Reply
CONDITIONS OF PERFECT MARKET: 1. Perfect competition(PC): no increasing returns, many buyers and sellers, all are price takers, not prices makers. 2. Perfect Information (PI): buyers and sellers know all they need to know about what they are buying and selling to make the right decisions.
Mallekha
3. Complete Markets(CM): no externalities or public goods, no transactions costs, "thick" markets.
Mallekha
nice contributor
Mohammed
A numerous downsized market that does not meet standards.
LaTasha
A Perfect Market is a numerous downsized market that does not meet standards.
LaTasha
what is a market
Ahmadou
is place where buyers and sellers met together for the purpose of buying and selling of good and services
Babakura

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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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