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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).

Problems

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
A B C
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

how does interest rate affect aggregate output
kelvin Reply
what is Keynesian theory
kelvin
need a curves for typical isoquost and isoquant
kelvin
what is isoquant
kelvin
isoquat is a curve shows differnt combinations of two inputs which can produce same level of output
Majid
examples of giffen goods
Getrude
then what isoquost
Peter
, if the price of an essential food staple, such as rice, rises it may mean that consumers have less money to buy more expensive foods, so they will actually be forced to buy more rice.
Peter
that's an example
Peter
majid Khan that's the wrong definition of isoquant
The
you are defining isocost
The
isocost curve is a locus of points that shows the different combinations of commodities purchased by a consumer with a fixed budget
The
The change in fiscal policy leads to an increased level of output and interest rates is because an increase in government expenses directly affects aggregate demand. A decline in taxes result in more disposable income, consequently leading to a rise in consumption expenditure.
Peter
dats for kelvin
Peter
dats d answer for the audio how does interest rate affect aggregate output
Peter
question not audio
Peter
u are right joker
Peter
what is journal entry?
Abel
explain the nature of economics
Matilda Reply
interpret micro economic issues
Matilda
ito ang dami ng producto na nais handa at kanyang ibenta ng isang prodyuser
Jomar Reply
i dont understand
Gaabshe
even I also don't understand ..this language.. vn I converse everybody say farzana ur language is not understood by all user? now no one there is question about it?
shaikh
he is saying that "this is the amount of product it wants to be ready and sells by a producer"
Aman
I Merr has knowledge,which is the economiccircuit role in a society
Ramadan
What is diminishing returns?
Shadrach Reply
explain competitive demand
ADENIJI Reply
the demand that are compiting for sale. the buyer can substitute one for another good
Iftikhar
yg
Margarette
the demand where commodities fight for the market. in this type of demand, commodities can be substituted for the most suitable one subject to ( price, consumers choice, consumers income etc)
WILSON
Demand is said to be competitive when a commodity that is needed to satisfy wants in place of another similar goods. increase in price of a commodity X will result in increase in demand of the substitute (commmodity Y).
yusuf
examples of giffen goods are garri (cassava), maize
yusuf Reply
what is Public Finance?
kweku Reply
it's basically the field of economics that deals with the government's involvement in the economy; from spending to maybe interest rate manipulation, etc.
Matthew
examples of giffen goods
Getrude
i want to get the solutions of problems how i get kindly give guidance
Syeda Reply
please give some suggestions about getting solutions of all chapters...
Syeda
hard work
Iftikhar
and the grace of God
The
knowledge skills
MUSA
Syeda Economics is difficult. No all fields are difficult
The
what is Keynesian
AKINOLA
Keynesian economics is the theory proposed by Keynes( an economist). He proposed to manipulate demand side factors to bring economy out of depression in 1930s.
Champro
whose totaly oppossid the government intervention and give importance to agreegad demand
Iftikhar
Good afternoon my fellow forum brothers and sisters
Abdullahi Reply
no just want to know true God
Suprim
Good afternoon!!
Martha
hey is there somebody single n young like me bcoz I'm looking for
Suprim
what is facing trade offs
Nancy Reply
It is giving up a commodity to purchase another commodity
The
for example, when we have two commodities like chicken and turkey you can trade off of give up chicken to purchase turkey
The
that can also be called foregone goods
AKINOLA
it like opportunity cost
AKINOLA
it's like trade by batter
Abdullahi
Do you transform into thesecourses, in french people?
Ramadan
I can just speak french andI can just speak french and no english
Ramadan
what is elastic
Tida Reply
elastic is the change in to price and change in demand
ehtesham
Is the percentage change in quantity demand and quantity supply.
Robert
Or percentage change in price of demand and supply
Robert
Right
ehtesham
Robert Mensah you are explaining elasticity of demand
The
robert i think he talk about elastic releated to elasticity of price a proportionate change in price over qd
Iftikhar
can anyone explain what happrn her i don't understand anything
Brahim
is the percentage change in demand as price change
MUSA
sometimes price is elastic,inelastic
The
price elasticity is different from price being elastic
The
elasticity is not always the percentage change in demand as a result of changes in price. there's income elasticity and cross elasticity so it's not necessarily always price
The
elastic is when a change in price of a commodity results in a relatively a larger proportion change in the quantity demand of the commodity
Nancy
what is inelastic
Tida Reply
price is said to be inelastic when it is less than 1
The
what is national income accounting
Aisha Reply
National income is the income earned by all factors of production..
Majid
So this benefits the workers or the businesses?
Neil
Like whose income are we talking about here
Neil
what is multiplier
Khalid
Good & services manufactured in a country with in one year is calld national income
Fani
incom earned by using of sources of production is national income while i dont know the accounting insuch
Iftikhar
neil and aisha can u explain the turm accounting in such question
Iftikhar
I think when we include accounting national income accounting is the measurement of total goods and services produced in an economy in a given period of time
The
what is mutual funds
Khalid Reply
it is a combination of financial securities such as treasury bills , bonds etc in one managed by an institution that individuals and firms invest in for profit. it is usually a long term investment and is seen as a low risk investment because the financial instruments invested in, are diversified.
Ekeanyanwu
A mutual fund is a professional managed investment that pools money from many investors to invest.
Malik
could you please recommend me any book to understand game theory
Prtj Reply

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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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