RL30534: America's Growing Current Account Deficit: Its Cause
and What It Means for the Economy

Marc Labonte

Economist
Government and Finance Division

Gail E. Makinen

Specialist in Economic Policy
Government and Finance Division

Updated April 19, 2001

CONTENTS

• Summary
• The Growing Trade Deficit and Its Importance to Congress
• What Has Caused the Growth in the Trade Deficit?
• A. The Movement of Capital to the United States
• B. Foreign Goods Are Dumped in the American Market
• C. Recessions or Slow Growth Abroad Are Reducing U.S. Exports
• D. Trade Barriers
• Some Additional Thoughts on the Nature of Capital Movements
• How Does the Purchase of U.S. Assets by Foreigners Affect the Economy?
• 1. Aggregate Demand or Spending
• 2. The U.S. Capital Stock
• 3. The Nature of Job Creation
• The Trade Deficits of the 1980s and 1990s: Are They Different?
• Can the U.S. Continue to Run Such Large Trade Deficits?
• Policy Options for Eliminating the Trade Deficit
• Conclusions
• Footnotes

Summary

The U.S. current account deficit, popularly known as the trade deficit, is on the rise. ⁽¹⁾ Over the current economic expansion it has grown from 0.2% of GDP in 1991 to a record high of 4.4% of GDP in 2000, which exceeded the previous high of 2.8% reached in 1986. This growth was particularly rapid over the period 1998-2000. During 1997, the trade deficit was a modest 1.4% of GDP.

Four major reasons have been given for the growth of the deficit: the inflow of foreign capital motivated by either profit or safety, the dumping of foreign goods in the American market, recessions or slower growth in the economies of major U.S. trading partners, and barriers imposed against U.S. goods and services by foreign countries. A compelling case can be made that the dominant cause of the deficit and its growth is the inflow of foreign capital. The movement in the foreign exchange value of the dollar is incompatible with the other given or suggested causes.

The inflow of foreign capital (and the related trade deficit) has a number of discernable effects on the U.S. economy. First, as a component of aggregate demand, a growing trade deficit reduces the growth of domestic demand as American spending is diverted from domestic goods to foreign substitutes. Second, because it represents foreign saving coming to the United States, it reduces American interest rates and encourages the growth of interest-sensitive domestic spending by businesses on such things as plant and equipment and by households on housing, automobiles, and appliances. On balance, however, the net effect on spending is negative. There is a third and indirect effect which must also be considered. Lower interest rates in the U.S. encourages higher equity or stock market prices. Since equities are a major part of the financial wealth of households, higher equity prices are thought to be an important determinant of consumer spending and, thus, a positive influence on aggregate demand. In fact, this may play a large role in the current economic expansion. Fourth, the inflow of foreign capital enables the United States to put in place a larger capital stock than would otherwise be the case. Finally, while the expansions of the 1980s and 1990s have demonstrated that a large trade deficit is no barrier to the attainment of full employment, they do affect the type of jobs that are created in the United States.

Over the longer run, a growing foreign ownership of the American capital stock means that a growing fraction of U.S. income growth will have to be transferred abroad. And this is increasingly evident in U.S. data. Over the period 1979-1984, U.S. net earnings abroad averaged $33.4 billion per year. In 2000, the U.S. paid net to foreigners about $8 billion for a shift of about $41 billion.

The Growing Trade Deficit and Its Importance to Congress

A noticeable phenomenon of the 1980s was the growth in the U.S. trade deficit to record proportions. From a slight surplus in 1981, the trade deficit grew to a record 2.8% of GDP in 1986. The trade deficit then declined to a low of about 0.2% of GDP in 1991. It then began to rise, reaching a record high of 4.4% of GDP in 2000. The growth of the deficit was especially rapid over 1998-2000. During 1998, the deficit was 2.6% of GDP while in 1997 it was only 1.4% of GDP. ⁽²⁾

What Has Caused the Growth in the Trade Deficit?

Four major explanations have been offered for the growth in the deficit. Foreigners' desire to invest in the United States, the dumping of foreign goods in the American market, the recession or slow growth in the economies of Asia and the major trading partners of the United States, and barriers imposed on U.S. goods and services by foreign countries. While several of these explanations will be shown to have some possible validity, the capital inflow explanation is the only one consistent with the movement in the foreign exchange value of the dollar. This explanation for the growing trade deficit would receive support from most economists.

A. The Movement of Capital to the United States

The key to understanding this explanation for growth in the trade deficit is to realize that capital comes to a country not in the form of money, but in the form of a trade deficit. With that in mind, assume that many foreigners, fearful of the security of their wealth, want to convert it into U.S. assets (or, alternatively, they want to buy higher-yielding U.S. assets). To do so, they must first buy American dollars. This will increase the net demand for dollars in the foreign exchange market and, all else held constant, the dollar should rise in response (or appreciate). The appreciation of the dollar should raise the price in foreign countries of American goods and services and reduce the price of foreign goods and services in the United States. As a result, the total value of American exports should fall and the total value of imports into the United States should rise. ⁽³⁾ The net result should be a rise in the U.S. trade deficit. In this explanation, the growing trade deficit goes hand-in-hand with an appreciating dollar.

B. Foreign Goods Are Dumped in the American Market

This explanation implies that foreigners, for whatever reason, offer their goods at cut rate prices. As a result, Americans switch from buying domestic substitutes to the now cheaper foreign goods. This shift in domestic demand to imports should increase the net supply of dollars in the foreign exchange market and, as a result, the dollar should fall in price or depreciate. ⁽⁴⁾ The net result should be a growing trade deficit that goes hand-in-hand with a depreciating dollar.

C. Recessions or Slow Growth Abroad Are Reducing U.S. Exports

Clearly, the economies of a number of Asian countries including Japan as well as those of the other major trading partners of the U.S. have not matched our high growth rates. When countries are in recession with falling incomes or their income growth is slow, their ability to buy goods is reduced (or slowed relative to American ability to buy their goods). Since some of these goods are made in America, it might be expected that U.S. exports will be adversely affected. However, this explanation requires that the growing American trade deficit be linked to a depreciating dollar. For if foreigners reduce their purchase of American goods and services they will also reduce their demand for dollars in foreign exchange markets. The reduced demand for dollars should, all else held constant, cause the price of the dollar to fall; the dollar should depreciate. ⁽⁵⁾

D. Trade Barriers

On March 31, 2000, the Office of the U.S. Trade Representative issued a 434 page report, that, among other things, detailed various practices foreign governments use to discriminate against American goods and services of an exportable nature. An important implication of this document is that if these practices did not exist, U.S. exports would be larger and the trade deficit would be smaller.

While there is no doubt that U.S. exporters face trade barriers imposed by foreign governments, there is substantial doubt that these barriers are either responsible for the trade deficit itself or for the growth in the deficit over the 1990s. The reason for this conclusion is straightforward. Suppose that trade between the United States and the rest of the world is balanced: the dollar value of U.S. exports is equal to the dollar value of U.S. imports. Suppose now that the rest of the world imposes barriers on U.S. exports (a tariff) such that export revenues fall. As exports fall in value, in the face of an unchanged value of imports, a trade deficit will emerge. Individuals who argue in this way are holding constant a vital price: the exchange value of the dollar. And it is because they do that they draw an incorrect conclusion. With the decline in foreign spending on American goods comes a decline in the demand for dollars in the foreign exchange market. As a result, the dollar will fall in value or depreciate. And depreciation will restore equilibrium to the trade balance. It will do this in two ways. First, by lowering the price of U.S. goods abroad, it will encourage some additional spending by foreigners on those goods. Second, by increasing the price of foreign goods in the United States, Americans will be induced to spend less on imports. And it is primarily through a reduced spending on imports that balance will be restored to the trade accounts. ⁽⁶⁾

The net effect of the imposition of trade barriers is not a trade deficit, but reduced spending by Americans and foreigners on each others goods and services or on the level of spending on imports and exports. ⁽⁷⁾

If the trade barriers explanation has any relevance to recent U.S. trade statistics, it implies that dollar depreciation should go hand-in-hand with a reduced level of trade, not a trade deficit. The data do not agree with this interpretation.

Thus, the behavior of the foreign exchange value of the dollar is an important piece of evidence in resolving the controversy over the growth in the trade deficit. The data in figure 1 show than since mid-1995 the dollar has been appreciating. This is consistent with the "movement of capital to the U.S." explanation and implies that the rise in net capital imports is the dominant explanation for the growing trade deficit. It does not preclude the other explanations from having had some effect on U.S. foreign trade. The movement in the exchange rate seems to preclude them from having had a dominant effect.

Some Additional Thoughts on the Nature of Capital Movements

It is argued that capital movements do not drive the trade balance, as the above analysis suggests. Those holding this view argue that cause and effect are the other way around: the trade balance drives capital movements. And, this fact renders the above analysis incorrect. What is the nature of this argument and is it relevant to recent American experience?

The type of capital movement noted in the previous section is referred to in the literature as an autonomous capital movement or one motivated by fear or a desire to earn a higher rate of return abroad. As such, they are associated with movements in the exchange rate of the type presented above. When a country is a net recipient of an autonomous capital inflow, it's currency appreciates in value and the net inflow of capital is represented by a trade deficit.

There is, however, another type of capital movement. It is often referred to in the literature as an induced capital movement because it is induced by prior movements in exports and imports. Suppose, for example, that the U.S. grew more rapidly than its trading partners and thus spent more on imports than the partners spent on American exports. ⁽⁸⁾ Under normal circumstances this would lead to a depreciation of the dollar and a closing of the trade imbalance as discussed earlier. This need not be the case. If all of these goods and services were paid for by checks, foreign banks would acquire a net claim on U.S. banks represented by the trade deficit. These balances are a capital flow in the same sense as if foreigners had purchased U.S. bonds or equities. They are, however, an induced capital inflow. This inflow would not have occurred without the prior trade imbalance in goods and services.

Is the growing inflow of capital to the United States dominated by an induced inflow? The answer is likely to be a resounding no. The net inflow is dominated by autonomous inflows. The reason being that an induced capital inflow should have very little effect on the exchange rate - it is, in effect, exchange rate neutral. As the above analysis makes clear, an induced capital inflow prevents the exchange rate from depreciating to restore equilibrium between the value of exports and imports. Thus, if induced flows dominate the net inflow, one would expect the growth in the trade deficit to go hand-in-hand with little movement in the exchange rate. And, from figure 1, it can be seen that this is not the case. The growth in the trade deficit has been associated with an overall appreciation in the value of the dollar. And this is the movement suggested by a net inflow dominated by autonomous capital movements. This is not to say that induced inflows do not play some role in the overall net inflow of capital. It is to say that the role is likely to be minor.

How Does the Purchase of U.S. Assets by Foreigners Affect the Economy?

When foreigners want to hold a larger value of American assets, the resulting trade deficit (or growth in the trade deficit) has four discernable effects on an economy:

1. Aggregate Demand or Spending

The direct effect of a trade deficit (or the growth of a trade deficit) is to reduce aggregate demand (or the growth in demand) for American goods and services. This is because spending on imports represents a demand by Americans for foreign output. Since a trade deficit means that that demand is not offset by foreign spending on American output (U.S. exports), on balance, the net demand for American output must be lower than it would be without the deficit. Thus, the direct effect of a trade deficit is a lower level of demand for U.S. output. And, a growing trade deficit reduces the growth in aggregate demand in the United States.

However, a trade deficit has several indirect effects that tend to expand spending for American goods and services. First, since the trade deficit is the way foreign capital or saving comes to the United States, it reduces American interest rates from what they otherwise would be. And lower interest rates stimulate interest-sensitive spending by American businesses and households. This includes spending on such durable goods as plant and equipment, housing, automobiles, and appliances. Second, lower interest rates tend to increase the prices of equities and this augments the financial wealth of households. Feeling wealthier, households are supposedly induced to save less and spend a higher proportion of their disposable income. It has been argued that such consumer spending has played an important role in the continuation of the current economic expansion. Overall, the general consensus is that a trade deficit, on balance is contractionary. Thus, the overall effect of a growing trade deficit is to slow the growth of aggregate spending in the United States. ⁽⁹⁾

2. The U.S. Capital Stock

An important attribute of a growing economy is a growing net per capita capital stock. How much that stock can grow is basically determined by the net saving rate of a country or how much of its gross saving is left after being used to replace the capital that is depreciated or used up in the process of producing output. The net national saving rate of the United States has been falling over the post-World War II period and is now low -- averaging about 6% of GDP over the last 4 years (versus about 11% during the decade of the 1960s and nearly 9% over the decade of the 1970s). With a trade deficit during the 1990s that averaged nearly 2% of GDP, the U.S. is able to add to its net capital stock at a much faster rate than without this net inflow of foreign capital. Of course, a portion of the net capital stock is now foreign owned and the rewards to that capital will accrue to foreigners. This will require that a rising portion of U.S. output be transferred abroad. ⁽¹⁰⁾ And, in fact, this is occurring. Before the large trade deficits that began in the mid-1980s, the U.S. received a net income from its foreign capital holdings that averaged about $33.4 billion during the peak years 1979-1984. By 2000, the U.S. paid net to foreigners about $8 billion a year. This is a net shift of about $41 billion a year.

3. The Nature of Job Creation

From the discussion above it can be seen that a growing net inflow of capital usually implies a rise in the amount spent on imports and a fall (either absolute or relative) in the amount spent on exports. This translates into a decline in jobs that are or would be created in the import competing and export sectors of the economy. This is offset to a degree by jobs that are preserved or created in the interest sensitive sectors of the economy. This change in the employment mix should be distinguished from the total employment in the economy. During both the long expansion of the 1980s and the 1990s, the U.S. managed to achieve full employment, if not overfull employment. ⁽¹¹⁾ Thus, the large and, at times, growing trade deficits of those two decades have not been a barrier to achieving full employment in the United States.

The Trade Deficits of the 1980s and 1990s: Are They Different?

The growth in the trade deficit during the 1980s closely paralleled the growth in the federal budget deficit giving rise to the so-called "twin deficit" theory. This is not the case in the 1990s. In fact, the opposite has occurred. As the federal budget has moved from deficit into surplus, the trade deficit has grown absolutely and as a fraction of GDP. What does this mean? It basically means that trade deficits can have several causes. In the 1980s, the prevailing view was that the growth in the federal budget deficit put upward pressure on U.S. interest rates. Other things constant abroad, this led foreigners to desire to buy American assets and, in the process of doing so, the dollar appreciated and the resulting trade deficit represented the net inflow of capital to the United States.

The 1990s present a more complicated picture. The rise in the productivity of U.S. capital, not widely experienced abroad, is believed to have raised desired investment in the United States. Since domestic saving was insufficient to accommodate domestic investment, foreign capital was drawn in to the country. Additionally, financial turmoil in Asia and Russia caused foreign saving to flee to the safety of the United States, making higher domestic investment possible. Through the same process the dollar appreciated and the trade deficit grew to reflect the enlarged net inflow of capital to the United States.

In both cases, the growth in the trade deficit resulted from a desire to purchase American assets. In that sense, the proximate cause of the trade deficit is the same. The motivation for doing so, or the ultimate cause, however, may have been different: in the 1980s it was higher yields that resulted from American fiscal decisions while in the 1990s it was a desire to participate in the enhanced productivity of the American economy and because of the safety of U.S. assets. ⁽¹²⁾

Can the U.S. Continue to Run Such Large Trade Deficits?

Since the trade deficit arises primarily because foreigners desire to purchase American assets, there is no economic reason why it cannot continue indefinitely. The consequence is a growing foreign ownership of the capital stock of the United States and a rising fraction of U.S. income that must be diverted overseas in the form of interest and dividends to foreigners.

A trade deficit is sustainable as long as the capital lent to the U.S. generates enough growth to service the borrowing costs the loan generates in the future. Borrowing can be used in two ways - for investment or for consumption. In fact, there was a private investment spending boom in the late 1990s at the same time the trade deficit was growing. If markets work efficiently and individuals are rational, then one would expect that investment would yield high enough returns overall to service these debts in the future. Alternatively, a few economists fear that much investment was driven by an unsustainable, speculative "asset bubble" in the late 1990s. For example, they believe that the stock market reached valuations that could not be justified by realistic predictions of future profits. If this were the case, future debt service could be difficult.

Unfortunately, if the trade deficit is primarily used for consumption, servicing excessive borrowing for consumption is unlikely to be as sustainable in the future. This was one reason that the 1980s trade deficit was a cause for concern among economists - it was strongly influenced by the budget deficit, and most government spending is dedicated to consumption not investment. Since the budget is now in surplus, one cause for concern has been eliminated. But the behavior of households today offers another cause of concern to some economists. The household saving rate has been declining throughout the decade. In 2000 it became negative - overall, households were net borrowers. Although the (negative) household saving rate is much smaller than the trade deficit, to the extent that foreign capital enables this borrowing to occur, it may make the trade deficit unsustainable.

It is difficult to disentangle from the data useful information on whether most foreign capital is being directed towards consumption or investment. It is impossible to predict what proportion of investment will be profitable and what proportion is being driven by a bubble because admitting the existence of a bubble requires the relaxation of the assumptions that markets work efficiently and investors are rational. Without these assumptions, any empirical measurement becomes impossible. In fact, these assumptions are so canonical to mainstream finance theory that the theory is largely unwilling to admit the possible existence of a bubble. Thus, accurate and meaningful analysis of the sustainability of the trade deficit on these grounds is impossible.

Some economists have tried to calculate rough rule-of-thumb estimates of the sustainability of trade deficits. Two leading international economists used the debt owed to foreigners as a percentage of GDP as such a rule-of-thumb estimate. They found that in 1999 this measure was about 20% of GDP, the highest it has been in U.S. history since the 19^th century. ⁽¹³⁾ Were trade deficits to continue at over 4% a year, this measure would reach 90% of GDP in a few decades. Although the yearly debt burden that this implies is relatively small, many countries that have experienced financial crises in the post-war period had debt to smaller GDP ratios, between 20-80% of GDP. They take this to be an indication that the U.S. trade deficit is unsustainable at this size. ⁽¹⁴⁾

Some economists fear that a large trade deficit is symptomatic of wider economic imbalance. They see it as a leading indicator for future inflation because it is a proxy for either consumption outpacing production or an investment bubble. In developing countries, it has often been a leading indicator of financial and/or currency crisis, although the applicability of this comparison with the U.S. may be limited, especially since the U.S. has a flexible exchange rate regime. They would see a tightening of monetary policy as the appropriate response to an excessively large trade deficit - not because the trade deficit itself is detrimental but to prevent future inflation from occurring. But in the late 1990s, few other leading indicators warned of mounting inflationary pressures.

It should be re-emphasized that economic theory does not suggest that a slow decline in the trade deficit would be troublesome for the overall economy. In fact, it would be expected to have an expansionary effect on the economy, since the increase in net exports would have a more stimulative effect on aggregate demand in the short run than the decrease in investment and interest-sensitive spending. Historical experience seems to bear this out - the trade deficit declined continually in the late 1980s from 2.8% of GDP in 1986 to near zero in 1990. Yet economic growth was strong throughout the late 1980s.

A possibly serious short run problem could emerge if foreigners suddenly decided to reduce the fraction of their saving they send us in the form of a capital inflow or if they suddenly decided to repatriate part of their liquid capital. The initial effect could be both a sudden and large depreciation in the value of the dollar as the supply of dollars on the foreign exchange market would increase and a sudden and large increase in U.S. interest rates as an important source of saving was withdrawn from the financial markets. It is doubtful that the direct effects of these shifts in lending patterns by foreigners could cause a recession. This is because the desire of foreigners to hold fewer dollar assets would lead via dollar depreciation to a trade surplus (or smaller deficit). And the move from trade deficit toward trade surplus is a move that expands aggregate demand. However, the indirect effects, which typically offset the direct effects only partially, could cause a recession if the change is sudden. ⁽¹⁵⁾ Large increases in interest rates could cause problems for the U.S. economy as they reduce the market value of debt securities, cause prices on the stock market to fall, and raise questions about the solvency of various debtors. Resources may not be able to shift quickly enough from interest-sensitive sectors to export sectors to make this transition fluid.

But is this a scenario that is probable enough that measures should be taken to avoid it? It is easy to imagine that a recession could cause the current account deficit and dollar to collapse. It is much harder to imagine a collapsing dollar and current account deficit causing a recession. It can be done only by making several unlikely assumptions. Adding these assumptions together, it seems safe to say that this threat is small.

The first assumption that must be made is that foreigners suddenly stop investing in U.S. assets. This seems highly improbable in the absence of a recession. Foreign investment opportunities may become relatively more attractive than opportunities in the U.S. over time, but under normal circumstances that would imply a slow dollar depreciation which, for the reasons outlined above, could not be economically disruptive. A sudden drop in U.S. investment, on the other hand, implies a panic that, although possible, seems hard to imagine. For many years, the United States has been considered a "safe haven" for investment. This was most starkly illustrated in 1998, when international financial panic caused investment to temporarily flow out of developing countries and into the United States. For foreigners to suddenly stop investing in the U.S., the exact opposite would need to occur: foreigners would suddenly become afraid to hold U.S. assets and seek out some other country's assets instead. But for what country would foreign investors suddenly spurn the United States when the United States has the broadest, deepest, and most transparent financial markets in the world?

The second assumption relies on the economic effects of the currency change working in the opposite way that they usually do. Typically, when a currency depreciates it has a positive effect on the growth of aggregate demand because the positive stimulus to export growth exceeds the negative stimulus to investment spending. For a depreciating currency to have the opposite effect, the negative effect on investment spending must exceed the positive effect on export growth. If the depreciation is large enough, this is possible: investors may be able to react to the change more quickly than exporters. But if this were the case, the effect by definition would be short lived.

The third assumption is that monetary or fiscal policy either would not be used to counteract the decline in investment spending or would prove ineffective. It is unlikely that the decline would be so large that lower interest rates, say, could not reverse its effect on aggregate spending. It is possible that policymakers would choose to allow for the decline, but only if they were more concerned with the value of the dollar than the state of the economy. Lower interest rates would probably exacerbate the dollar's slide and policymakers may find this undesirable. However, in recent history it can be argued that policymakers have tended to show much greater concern for domestic economic stabilization than for currency stabilization.

The fact that three unlikely events would need to come to pass for a sudden currency depreciation to cause a recession implies that little weight should be given to the argument that the current account deficit could cause a recession.

Policy Options for Eliminating the Trade Deficit

If the U.S. government were to adopt a policy to reduce or eliminate the trade deficit, what policy tools could it use? The discussion above implies that barriers to trade would not affect the trade deficit - a reduction in imports caused by barriers would be replaced by an increase in net imports caused by dollar appreciation. Even if stronger economic growth abroad could reduce the trade deficit - and the analysis above suggests that it may not - it is doubtful that U.S. policy can do much to boost growth abroad. ⁽¹⁶⁾

The discussion above implies that the current trade deficit is primarily a result of the fact that there are more attractive investment opportunities in the U.S. than can be accommodated by domestic saving alone. To reduce the trade deficit, one must reduce this imbalance. Obviously, a policy to reduce profitable investment opportunities in the U.S. would be counter-productive. Instead, a policy to reduce the trade deficit must aim to increase the domestic saving rate. The government may be able to do so by making saving more profitable and increasing the incentives to save. The government can make saving more profitable by lowering the taxes on saving. It can increase the incentives to save through the creation and extension of tax-favored savings accounts. The empirical evidence about the effectiveness of lower taxes and government saving incentives as policies to increase saving is mixed, however. ⁽¹⁷⁾ Nevertheless, there is a more direct way for the government to increase the national saving rate - it can pursue a policy of increased budget surpluses. National saving is determined by households, corporations, and the government. When the government runs a surplus, economic theory holds that it results in more domestic saving being available for private investment. ⁽¹⁸⁾

Conclusions

The U.S. trade deficit is made possible by the net purchase of U.S. assets (stocks, bonds, real estate, etc.) by foreigners. ⁽¹⁹⁾ This deficit includes the traditional types of imported goods familiar to American consumers (cars, stereos, cameras, etc.). Because the trade deficit is a component of aggregate domestic demand and sudden fluctuations in the deficit can cause sudden changes in income growth and employment, Congress has been concerned about its growth, especially the sharp increase during 1997-2000.

An increased desire by foreigners to purchase American assets can affect the economy in several ways. First, it directly reduces the growth in aggregate demand since the difference between the value of exports and imports is a component of demand. This is offset in part by the lower interest rates made possible by the capital inflow. As a consequence, it would be difficult for a growing trade deficit to actually cause aggregate demand to contract in the United States. Second, the inflow of capital makes possible a larger addition to the net national capital stock than would be possible from net domestic saving alone. Third, it can affect the composition of jobs that are created. Moreover, history has shown that the trade deficit is no barrier to achieving full employment.

Any sudden shifts in foreign preferences for American assets can cause potentially large changes in the exchange rate and domestic interest rates, both of which can be disruptive to the orderly growth of output and employment in the United States.

Footnotes

1. ^(back)For purposes of this report, the current account deficit is measured by the excess of imports over exports in 1996 dollars as reported in the National Income and Product Accounts. In the text, it will be referred to as the trade deficit.

2. ^(back)In all of the computations above, exports, imports, the difference between the two, and GDP are measured in 1996 dollars.

3. ^(back)This need not be an absolute fall in the value of exports and rise in the value of imports. The analysis is consistent with a fall in the growth rate of exports and a rise in the growth rate of imports.

4. ^(back)Note that the fact that foreign goods are offered at a lower price in the United States is not dispositive of a conclusion of dumping. The fall in the dollar price of foreign goods is a part of the adjustment mechanism in A above by which foreign capital comes to the U.S.

5. ^(back) Explanations B and C cannot, technically speaking, produce a current account or trade deficit. If there were no capital movements, the exchange rate would depreciate by a sufficient amount to eliminate the deficit. Thus, the existence and persistence of a current account deficit is itself evidence that a net capital inflow to the U.S. has occurred.

6. ^(back) To the extent that there are lags and market imperfections, there may be temporary imbalances, but in time this adjustment will take place.

7. ^(back) Interestingly, the effectiveness of trade barriers can be increased without the need for legislative action. Tariffs, for example, are often "specific" in nature, such as 10 cents per ounce or $5 dollars per ton, etc. Should prices fall, the real level of protection offered by specific tariffs will increase as the world discovered during the Great Depression of 1929-33. This is not true for tariffs that are expressed as a percent of value or that are "ad valorem" in nature.

8. ^(back) Even more to the point, this imbalance could be caused by the imposition of trade barriers on American goods and services by foreigners.

9. ^(back) While a trade deficit can produce a slowing in the growth rate of aggregate demand, it is doubtful if it could produce an actual contraction in aggregate demand in the United States.

10. ^(back)However, some of the rewards of foreign investment will accrue to American workers, enabling them to enjoy a higher standard of living than they otherwise would.

11. ^(back)Macro economists define full employment relative to a stable rate of inflation. Thus, the full employment rate of unemployment is the unemployment rate compatible with a stable rate of inflation. Empirical estimation including data for the 1990s places that rate in a 5% to 6% range. Estimates using data through the 1980s would produce a similar range.

12. ^(back)For a more extensive discussion of this subject, see U.S. Library of Congress. Congressional Research Service. Why the Budget Deficit and the Trade Deficit Haven't Been Moving Together. CRS Report 97-985 (pdf)E by Gail Makinen.

13. ^(back)By contrast, total financial capital was 425% of GDP in 1999.

14. ^(back)Maurice Obstfeld and Kenneth Rogoff, Perspectives on OECD Economic Integration: Implications for U.S. Current Account Adjustment, working paper presented at Federal Reserve Bank of Kansas City Jackson Hole Symposium, August 2000, p. 24.

15. ^(back)The principal indirect effect would be on consumption expenditures. The rise in the fraction of household disposable income devoted to consumption is thought to be due, in part, to the rise in the equity wealth of households. A sharp rise in U.S. interest rates could cause a sharp fall in equities values on stock markets decreasing household wealth and, consequently, consumption spending.

16. ^(back)See U.S. Library of Congress, Congressional Research Service, Does the U.S. Serve as the World Economy's Engine of Growth? by Marc Labonte and Gail Makinen, CRS Report RL30846.

17. ^(back)For example, see the symposia "Government Incentives for Saving" in the Journal of Economic Perspectives, v. 10, n. 4, Fall 1996 and "Tax Policy: A Further Look at Supply Side Effects," American Economic Review, v. 74, n. 2, May 1984.

18. ^(back)For more information, see U.S. Library of Congress, Congressional Research Service, What if the National Debt Were Eliminated? Some Economic Consequences, by Marc Labonte, CRS Report RL30614.

19. ^(back)This does not preclude the dumping of foreign goods in the American market and recessions abroad from playing a role. Trade barriers could possibly play a role provided that they induce capital movements, which is highly unlikely given the size of the trade deficit.

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